Don’t Make These 3 Mistakes When Planning Your Estate

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The 3 most common mistakes when structuring an estate can have dire implications. Make sure your estate plan anticipates for and provides a strategy for worst-case situations.

Gifting Assets

The current unified estate and gift exemption is $11,200,000 per person. This means you can give to your heirs, or they can inherit from you, up to the limit before any gift or estate taxes are due. If a person gives over $15,000 per year to an individual a federal gift tax return needs to be filed and the estate exemption will be reduced by the amount gifted over $15,000—hence the term Unified Estate and Gift Exemption.

Most people fall below the exemption amount. Because for most people no gift or inheritance taxes will be due when a gift is received or an inheritance is received, many people believe there is no difference between the two. While this is true for gift and inheritance taxes—they are zero regardless—there can be a big difference in capital gain taxes.

If you inherit an asset the cost basis of that assets is stepped up to fair market value on date of death. Assuming the assets is sold at the fair market value, no capital gains taxes are due. If you receive the asset as a gift, however, your cost basis is the donors cost basis—you get no step-up in basis.

Let’s look an example:

John purchased some stock many years ago for $150,000. The stock has done well and is now valued at $300,000. John would like to help his son Jim. If he sells the stock and gifts the proceeds, John will have to pay capital gains taxes on the $150,000 gain. If he gives the stock to Jim, Jim will have to pay capital gains taxes on the gain as well since he gets no step-up in basis. However, if Jim were to inherit the $300,000 in stock he could immediately sell it and pay nothing in capital gains taxes.

Joint Tenancy with Rights of Survivorship Titling with Your Spouse

It is common practice for a husband and wife to title most of their assets in joint tenancy. While this is typically a good idea for their home and for depreciating assets, such as motor vehicles, it can be a bad idea for investment assets. If one spouse passes away the remaining spouse only gets to step-up the value on one half of the asset. In many cases this is unavoidable because we don’t know who is going to pass away first, but in the case of one spouse in poor health there is a tax planning opportunity.

If one spouse is in poor health while the other is very healthy it can make very good sense to switch title to the unhealthy spouse. If at least one year passes before the unhealthy spouse passes away, the healthy spouse will inherit the assets with a full step-up in tax basis, resulting in no taxes if the asset(s) are sold before they appreciate further.

Joint Tenancy with Rights of Survivorship Titling with a Non-Spouse

A do-it-yourself estate planning strategy I often see is putting a non-spouse on an asset as a joint tenant. The primary reason to do this is to avoid probate on the asset, which is accomplished. The problem with this approach is that if the added joint tenant survives the original sole owner, the survivor will get no step-up in cost basis since the survivor did not contribute anything towards acquisition of the asset. The result is the same as if the asset were gifted.

Another issue with the strategy is that joint tenancy equates to joint liability. Again, this is best illustrated with an example:

Mary has only one heir, her granddaughter Sally. When Mary dies she doesn’t want Sally to have to go through the probate process to settle her estate so she changes title of her savings account, her investment account and her home to Joint Tenancy with Sally as the joint tenant.

Unfortunately, Sally is at fault in a car accident where she takes out a $200,000 Ferrari driven by a doctor who is permanently disabled. A $5,000,000 judgement is levied against Sally, who only has a $65,000 combined liability limit on her vehicle insurance. One half of all of Mary’s assets are now subject to the claim. As bad as that is, it gets even worse. Assuming Mary mortgaged her house to allow Sally to partially cover the claim and then dies, the remaining equity can now be included in the claim. Sally would have to sell everything to satisfy the claim and she would be subject to capital gain taxes on the gains realized.

If you want to see how bad this works out for Sally, put the following in the calculator below:

  • Sally’s Salary $40,000               Put that in first to get her baseline taxes
  • Home Value $350,000              Put that in next as a long-term capital gain

Sally’s federal tax bill goes up to $61,300 from her baseline of $3,746, so it cost her $57,554 in taxes to sell the home. Remember, the claim against her had a lien against the home so after paying off the mortgage (that they took out earlier) Sally is left with nothing to use to pay her taxes—she can probably work out a payment plan with the IRS but she is in terrible shape financially. All of this could have been avoided with a well thought out estate plan for Mary.

While we do not give legal advice, we would be happy to review some of these issues with you and if there is an opportunity for improvement we can refer you to one of our tax or legal associates. It never hurts to have a second set of experienced eyes looking things over.



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