I spend a lot of time reading articles and researching different financial and tax related topics. I recently read an article on Kitces.com that caught my eye. Here is a summary (as their articles are pretty in-depth for people who don't eat, live and breathe financial planning every day).
The article talks about estate income tax planning and jointly held assets. Under current law, very few of us will have to worry about estate taxes at the Federal level. That doesn't mean that effective estate planning can't reduce the family's overall income tax burden. It has to do with step-up in basis.
If you live and will continue to live in a community property state (WA, ID, CA, NV, AZ, NM TX, LA, WI), you can probably stop reading (unless, of course, you have family members in other states). If you live in the rest of the US, you'll want to keep reading.
When you pass away, assets that are part of your estate receive a step-up in basis. What this means is the basis of the asset will reset to the value on the date death. For example, if you purchased IBM stock 20 years ago for $100 a share and on the date of your death the shares are now worth $200/share the basis will step up to $200/share. When whomever inherits the stock, his or her capital gain will be based on a basis (or purchase price) of $200/share and not pay any tax on the $100/share gain you earned during your lifetime. That is how it works if you own the asset yourself.
If you own the stock jointly with your spouse (or anyone else for that matter) and live in a non- community property state, also known as common law states, the step-up in basis will only be on the amount of the asset that belongs to the deceased spouse. For Joint Tenant with Right of Survivorship (JTWROS) and Tenant by the Entirety accounts that amount will equal 50%. So how would the above example work if the IBM stock is owned jointly. Let's say you bought 100 shares for a total of $10,000. Like above when you pass away the stock is worth $200/share or $20,000 for the lot. 50 shares will step up to $200 per share or $10,000 and the other 50 shares will not receive any step-up. The total 100 shares will now have a basis of $15,000. If your spouse sells the shares prior to his or her death, he or she will owe capital gains taxes on $5,000. Probably at least $750. $750 that would be in his or her pocket if you had owned the stock in your name. By the way, the same calculations apply if the assets are held in a trust where you and your spouse are joint trustees.
What to Do?
Obviously, none of us know with certainty the day we will check off this planet. But there are a few opportunities to reduce income taxes for the family through proactive planning
- Upon the diagnosis of a terminal condition, gift of assets to the ill spouse may be advisable
- If one spouse (especially a male spouse) is significantly older than the other spouse, it might be worth gifting the assets to an account is the elder spouse's name only
Things to Watch For
There is a one-year look back for gifted assets. If you, or anyone else, gifted assets to the decedent within a year of death, the assets do not receive a step-up in basis. Additionally, you definitely do NOT want to gift assets to a spouse that will require MEDICAID. The spouse will end up spending down the assets to qualify for MEDICAID. Better to pay the tax.
Finally, a gift is a gift is a gift. Once the individual spouse controls the asset, he or she can do whatever he or she wants to with it. In other words, the spouse who gave away an interest in the asset may end up with nothing upon the death of the spouse who received the assets. There needs be a lot of trust between spouses.
One last thing to mention, while the example above used stocks, the same step-up rules apply to assets like real estate and collectibles. It doesn't apply to what is called Income in Respect of the Decedent (IRD), the most common of which is IRAs.
Military Finances are Different
While this particular issue applies to civilians and active and retired military members the same way. That isn't always the case. When it comes to planning your future, we think that you should work with someone who deals with military and veteran benefits and tax law each and every day. If you'd like to chat with us about how we can help you out give us a call or schedule a meeting using the button below.
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