Remember Income Taxes When Doing Your Estate Plan

Estate planning is important for a number of different reasons. Making your intentions clear, avoiding a costly administration process, and keeping the process as simple and least burdensome to your loved ones are the most common I hear from my clients. What clients and advisers sometimes forget in this process are the impact of taxes and in particular income taxes.

There are two situations I see this come up with some regularity. One is when clients are making gifts to children or perhaps grandchildren. If a gift is something other than cash (i.e. real estate, investments, an interest in a business, etc.), the person who receives the gift will take on the same tax attributes. As an example, imagine you bought a cottage in the 1970’s for $50,000 and it has appreciated multiple times over (so it’s now valued at $500,000). If you sold it, you would have a tax bill of approximately $220,000 (the difference between the current value and what you paid for it, multiplied by the federal and Michigan income tax rate). So, if you decided to gift that cottage to your children and they later sell it, they will have to pay this significant tax bill.

Another situation arises when a couple has two separate trusts (which are commonly done to minimize or avoid estate taxes). If one spouse passes, the assets in that trust will be adjusted to the date of death value for tax purposes. Again, let’s look at an example to see an illustration of this. If a couple has these two trusts, and one of them passed in March of 2009, investments that were transferred to a trust at that time and later invested in the S&P would have appreciated 173% from that time until today. Let’s say $1,000,000 was invested and it then grew in value to $1,730,000. If these assets are then sold after the surviving spouse passes, this appreciation of 173% (or $730,000) will have over $214,000 of income tax due.

There are ways to avoid this income tax (perhaps saving multiple hundreds of thousands of dollars for your loved ones). If you are interested in how to minimize income taxes as part of your estate plan, please contact us at your convenience.

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