In “the old days”, which in terms of estate tax law, wasn’t that long ago, the estate tax rate was 55% and the exemption $600,000. In those days, we advised cilents to adopt AB Trusts in order to keep at least $600,000 out of the taxable estate of the surviving spouse.
Fast forward to 2016. The estate tax exemption is now $5,450,000 and the tax rate is 40%. Only .2% (yes, that is less than 1%) of the U.S. population is expected to have a taxable estate. Now the focus of tax related planning is on minimizing income taxes, including tax on capital gains.
Unfortunately, what was wise planning in the past is now not very smart today. By keeping assets out of the surviving spouse’s taxable estate when it is not necessary for avoidance of estate taxes, we are inadvertently missing an opportunity to avoid capital gains taxes. This is because upon death the assets that are included in a person’s taxable estate get an adjustment in their basis to make their basis equal to fair market value.
Basis is your historical cost. When you sell an investment, your gain is measured by the difference between your sale price and your basis. When a deceased person’s assets are included in their taxable estate, they get a new basis, which eliminates capital gains on those assets. (This is not applicable to retirement plan assets or annuities).
So for many of our clients, it is a good time to review their plans and move into a plan that does not involve AB Trusts. For some of our clients, those who have already lost a spouse, and find themselves now administering the irrevocable AB Trust of their deceased spouse, there are still some strategies that we can implement to achieve a step up in basis in the assets inside that irrevocable trust.
Come see us to discuss what your options might be.