The Importance of Income Tax Planning

Income Tax planning is an integral part of Estate Planning. This blog examines what happens to the income tax basis of an asset when it is gifted or bequeathed. There are different rules for the basis of an asset that is gifted to you that one you are given by the death of someone.

Let’s look at an example. James owned 100 shares of a stock he purchased for $50 per share. His basis in the stock was $50 per share, or $5,000. The stock skyrocketed in value to $1,000 per share, so his 100 shares were worth $100,000. Since James had other assets, he decided to give the shares to his daughter, Lisa, and then died the next day. Lisa’s basis in the stock was the same as James’ at the time of the gift. She has what is called a “carryover” basis. Let’s say Lisa sells the shares for $1,100 per share, or $110,000. Lisa will recognize a gain of $1,100 less her basis of $50, or $1,050 per share. Her total gain is $150x 100, or $105,000. She will be taxed depending on her other income.

However, the result would be quite different if James held on to the stock and then bequeathed it to Lisa at his death. It doesn’t matter whether the transfer is made by James Will, Trust, or even due to a beneficiary designation. It only matters that James owned them when he died. Let’s say the stock was worth $1,000 per share when James died and the shares were bequeathed to Lisa, rather than gifted to her. The basis of the shares of stock would have been “stepped-up” to their fair market value at James’ death. In other words, the basis would be $1,000 per share, or $100,000. When Lisa sells the 100 shares for $1,100 per share, or $110,000, she’ll have a gain of only $100 per share ($1,100 less $1,000) or 10,000, rather than $105,000.

These examples illustrate why it is typically best to give away assets that haven’t appreciated dramatically. As in most things, cash is king when gifting assets.

Gifting can be a powerful wat to reduce the taxable estate. But due consideration must be given to the choice of assets to gift.