Smart Tax Move for 2014: Forget Conventional Wisdom About Inheritance Taxes
December 11, 2013 - NEW YORK, NY
A standard tax strategy for high net-worth individuals -- reducing your estate to limit inheritance tax -- may no longer be the best move.
Estate tax rates have fallen and income tax rates have risen, so that making gifts to lower the size of an estate could lead to bigger income tax bills down the road.
"In the past, it almost always outweighed the income tax consequences if you received an estate tax benefit, because estate tax rates were so much higher," says Steven Eliach, JD, LLM, partner-in-charge of the Tax Practice at New York accounting firm Marks Paneth. "But rates have changed. And other provisions of the tax code serve to reduce the income tax bill for inherited assets."
Gifts to Reduce the Size of the Estate Can Lead to High Income Tax Bills
"The bottom line is, don't automatically assume that you do not need to pay the estate tax, because that may end up costing you more money," Mr. Eliach says. "When you do estate planning, you have to be much more aware of the income tax impact of the estate plan. There is a lot more number-crunching involved."
Mr. Eliach explains that several recent changes in the tax code have made it harder to choose between paying more estate tax or more income tax -- and in some cases may have shifted the balance in favor of income tax:
- The highest marginal estate tax rate, which was 55 percent just a few years ago, is 40 percent today -- not that different from the top marginal income tax rate of 39.6 percent (and not including the 3.8 percent surtax).
- There is no tax on the first $5.25 million of the estate (up from a recent level of $3.5 million).
- Finally, when assets are inherited, the cost basis "steps up" in value. "If you bought a share of stock at $1 and it's now worth $40, if you sold it, you'd have to pay capital gains tax on your gain of $39," Mr. Eliach says. "The same would be true if you gave it as a gift to move it out of your estate -- if the recipient sold it, the capital gain would still be $39. But if you died with the stock still in your estate, and the recipient inherited it, the cost basis would 'step up' to $40. The recipient would only have to pay tax on any capital gain above that level."
"In the past, the decision would have been easier -- you would gift the stock and the recipient would pay the capital gains tax, which was lower than the estate tax. But now, when rates are similar, the income tax hit on the gifted stock is high, whereas if you'd kept the stock in your estate, the income tax bill would be much lower -- and if the stock came under the estate's $5.25 million lifetime exclusion, it wouldn't have been taxed for federal purposes when it was inherited.
"Even if the recipient inherits, then holds the stock for 10 years, and it grows at 8-10 percent a year, the capital gains tax would still be significantly less," he adds.
"So in many cases, it may be smarter to keep the stock in the estate, and let the recipient use the so-called 'basis step-up' to pay a lower capital gains tax," Mr. Eliach says.
Gifting May Still Make Sense -- but be Careful About What Assets You Gift
Mr. Eliach explains that gifting to reduce the size of the estate may still make sense. "But you'll want to revisit your gifting programs and be more careful about what kind of assets you gift. It almost always makes sense to gift within the limits of the lifetime exemption. But it may be more advisable to gift cash, rather than securities that have a built-in, taxable gain," he says.
"What's dangerous is to assume that things are the way they were in the past," Mr. Eliach adds. "Changes in tax laws should persuade you to re-think your strategy."
Mr. Eliach is available for interviews and can author a bylined article. For more information, please contact Katarina Wenk-Bodenmiller of Sommerfield Communications at (212) 255-8386 or firstname.lastname@example.org.
About Marks Paneth
Marks Paneth LLP is an accounting firm with over 500 people, of whom nearly 65 are partners and principals. The firm provides public and private businesses with a full range of auditing, accounting, tax, consulting, bankruptcy and restructuring services as well as litigation and corporate financial advisory services to domestic and international clients. The firm also specializes in providing tax advisory and consulting for high-net-worth individuals and their families, as well as a wide range of services for international, real estate, media, entertainment, nonprofit, professional and financial services, and energy clients. The firm has a strong track record supporting emerging growth companies, entrepreneurs, business owners and investors as they navigate the business life cycle.
The firm's subsidiary, Tailored Technologies, LLC, provides information technology consulting services. In addition, its membership in Morison International, a leading international association for independent business advisers, financial consulting and accounting firms, facilitates service delivery to clients throughout the United States and around the world. Marks Paneth, whose origins date back to 1907, is the 34th largest accounting firm in the nation and the 16th largest in the New York area. In addition, readers of the New York Law Journal rank Marks Paneth as one of the area's top forensic accounting firms for the fourth year in a row.
Its headquarters are in Manhattan. Additional offices are in Westchester, Long Island and the Cayman Islands. For more information, please visit www.markspaneth.com.
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