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Wills: Income Tax Planning

While estate tax liability is an important consideration for those whose wealth exceeds the exemption threshold, income tax planning is a concern for far more individuals and couples during the estate planning process.

“Basis” and the Importance of Income Tax Planning

The estate planning implications of federal income tax have to do with the concept of “basis.” In very general terms, when you purchase an asset, your “basis” is the amount that you pay. When you eventually sell the asset, you must pay income tax on the difference between the asset’s basis and the sale price (presumably, the then-current fair market value). If you sell the asset at a loss, you can claim the loss as an income deduction. This is a gross oversimplification of a highly-complex set of IRS rules and regulations, but it is enough to illustrate the point.

When you transfer an asset at death, your beneficiary receives either: (i) a “stepped-up” basis that is equal to the then-current value of the asset if the asset has appreciated; or, (ii) a basis equal to the asset’s then-current fair market value if the asset has depreciated. While the stepped-up basis for appreciated assets can save your beneficiaries significant income tax liability, transferring a depreciated asset at death can have significant undesirable income tax consequences.

For example, suppose you own stocks that you purchased for $10,000 and that are worth $100,000 at the time of your death. While you would have owed income tax on the $90,000 in appreciation had you sold the investment during your lifetime, the beneficiary who receives the stock will receive a stepped-up basis of $100,000. Now, consider the opposite example: You purchased stock for $100,000 that is worth $10,000 when you die. If you had sold this stock prior to death, you could have claimed a $90,000 loss on your federal return. Instead, your named beneficiary will receive a $10,000 asset with a $10,000 basis—meaning that he or she will owe income tax for any appreciation above the current value (even though it is far less than you paid).

Planning Your Estate to Mitigate Income Tax Liability

As you can see from these simple examples, income tax can be a critical consideration during the estate planning process. For just about everyone, one of the primary goals of estate planning is to transfer as much wealth to intended beneficiaries as possible, while paying as little as possible to the government. If the income tax implications of lifetime gifts and bequests are ignored, the financial consequences can be substantial.

Regardless of your financial circumstances, it is important to ensure that your attorney factors federal income tax rules into your estate plan. If you prepared your estate plan prior to the enactment of the American Tax Payer Relief Act in 2012, it may important to reconsider the tax strategies in your existing plan as well.

Contact Us About Your Estate Plan

Helmer, Conley & Kasselman, P.A. is a New Jersey law firm that provides estate planning services to individuals and couples throughout the Garden State. To discuss your estate plan with one of our experienced attorneys, call 1-877-435-6371 or request a free consultation online today.

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