Articles

Considering the Tax and Non-Tax Motivations Behind Planning for the Transfer of Wealth

May 17, 2017

by Justin D. Prueitt

Even though it is possible that the Estate Tax and other wealth transfer taxes may soon be repealed, such repeal remains uncertain, and it is still important for some people to consider the potential effects of these taxes when planning for the transfer of their wealth during life and upon death.  However, aside from concerns of wealth transfer taxes, there are many non-tax reasons that motivate the majority of people to create an estate plan.  It is also important to note that estate planning is very important for many Non-Citizen Residents and Non-Citizen Non-Residents who own real estate in the United States or have heirs living or working in the United States or abroad that they want to provide for.

Important Non-Tax Considerations When Planning for the Succession of Wealth
Aside from all of the tax concerns that motivate estate planning (i.e., Gift Tax, Estate Tax, Generation Skipping Transfer Tax, Capital Gains Tax, Income Tax, and Property Tax), there are many other non-tax reasons to consider when deciding whether or not to speak with an experienced estate planning attorney about how to best plan for the transfer of property to loved ones.  Most people who seek estate planning assistance are primarily concerned about non-tax considerations, including, but not limited to, the following:

  • Stating how their heirs will be receiving property upon their death (i.e., outright, in trust for life, or in trust until a certain age),
  • Providing how their heirs will receive their property,
  • Making sure that undeserving heirs are disinherited,
  • Protecting against future litigation caused by heirs fighting over their inheritance,
  • Using spendthrift provisions in an estate plan to prevent financially irresponsible heirs from squandering their inheritance or to prevent an heir’s creditors or future divorcing spouse from having access to his or her inheritance,
  • Ensuring that their surviving spouse and children are the sole beneficiaries of the deceased spouse’s wealth in the event that the surviving spouse remarries,
  • Nominating who will act as the guardian of their minor children,
  • Providing for how their heirs or family members with special needs will be taken care of,
  • Selecting who will manage their financial and health care needs during their life if they become unable to do so for themselves, and
  • Avoiding the costs, time consumption, and lack of privacy of Probate if they do not yet have a living trust in place.

Even though there are numerous non-tax reasons that motivate many people to consider making an estate plan, for some people, estate planning can be a double edged sword upon which they must balance their non-tax estate planning motivations with their relative concerns of avoiding certain tax consequences.  What follows is a general discussion of the various kinds of taxes that can affect estate planning decisions.

Estate and Gift Tax
The current Estate Tax imposes a top tax rate of 40% on the value of a deceased person’s (“decedent”) estate that exceeds his or her available lifetime estate tax and gift tax exemption amount.  Separately from the lifetime exemption amount, many interspousal transfers where both spouses are United States citizens are completely exempt from the Estate Tax and Gift Tax.  For decedents dying in 2017, the maximum lifetime exemption amount is $5.49 million.  The lifetime exemption amount can also be applied to avoid any Gift Taxes that would have been due for gifts that the decedent made during the decedent’s lifetime.  A decedent’s available lifetime exemption amount at death is reduced by the amount used, if any, to avoid Gift Taxes on gifts made during the decedent’s lifetime.  

The current Gift Tax imposes a top rate of 40% on the amount of a gift that exceeds the gift maker’s annual Gift Tax exemption.  Currently, the annual Gift Tax exemption is a maximum of $14,000 of the total value of all gifts made in 2017 per each gift recipient.  This means that, in 2017, a person can make an aggregate amount of gifts totaling $14,000 per gift recipient to an unlimited number of gift recipients without incurring any Gift Tax liability.
Ultimately, the Estate Tax primarily affects estates of individuals that are close to or exceed $5.49 million and estates of married couples that are close to or exceed $10.98 million (two times an individual’s lifetime exemption amount).  Estates of this size only account for roughly 0.2% of Americans, or 1 out of every 500 people who die.  However, as discussed below, even individual estates of less than $5.49 million or estates of married couples of less than $10.98 million can benefit from tax planning in order to reduce or eliminate certain income and property taxes.

Married couples can plan to leave Estate Tax exempt property of the first spouse to die (the “deceased spouse”) to an irrevocable trust for the benefit of the surviving spouse or other beneficiaries chosen by the deceased spouse.  Alternatively, if neither spouse has any reason to be concerned about the Estate Tax or to be concerned about the wealth transfer implications of the surviving spouse remarrying after the death of the deceased spouse, then they can simply plan to give the deceased spouse’s entire share of the estate to the surviving spouse outright and free of trust.

If a married couple plans to allocate all of the deceased spouse’s Estate Tax exempt property to an irrevocable trust, such property can grow in that trust free of any future Estate Tax liability.  If, however, a married couple chooses to give all of the deceased spouse’s share of the estate to the surviving spouse outright and free of trust, the surviving spouse can add all of the deceased spouse’s remaining lifetime exemption amount to his or her own available lifetime exemption amount by timely filing an Internal Revenue Service Form 706 (Estate Tax Return) and making a special tax election thereon called a “portability” election.

Each year, an individual’s lifetime exemption amount is adjusted for inflation, which usually results in an annual increase in the amount of wealth a person can transfer free of Gift Tax and/or Estate Tax (i.e., $5.12 million in 2012, $5.25 million in 2013, $5.34 million in 2014, $5.43 million in 2015, $5.45 million in 2016, and $5.49 million in 2017).  If the portability election is made, unlike the surviving spouse’s lifetime exemption amount, the “ported” portion of the decedent’s lifetime exemption amount will no longer continue to be adjusted for inflation each year.  In other words, if portability is elected for the death of a spouse that occurred in 2017, and both spouses have not used any of their individual lifetime exemption amounts, then the surviving spouse could end up with a total lifetime exemption amount of $10.98 million for 2017 ($5.49 million multiplied by 2), only half of which would continue to be adjusted for inflation in subsequent years.  In that case, the surviving spouse could use his or her available lifetime exemption amount (adjusted for inflation) and the deceased spouse’s ported lifetime exemption amount (not adjusted for inflation) to avoid Gift Taxes during the lifetime of the surviving spouse, or to avoid Estate Taxes upon the death of the surviving spouse.

Generation Skipping Transfer Tax
The Generation Skipping Transfer Tax (“GSTT”) is a completely separate tax from the Estate Tax and Gift Tax, and it imposes a 40% top federal tax rate on generation skipping transfers made during the life or after the death of the transferor.  Certain kinds of wealth transfers can result in a generation skipping transfer.  

For example, a transfer from a grandparent to a grandchild made while the grandparent’s child (the parent of the grandchild) is still living is a generation skipping transfer. A transfer to a recipient who is not otherwise related to the person making the transfer by lineal descent or marriage, and who is more than 37.5 years younger than the person making the transfer, is also a generation skipping transfer. There are several other ways in which a taxable generation skipping transfer can occur, and it is important to confer with a professional before making large lifetime or at-death transfers of wealth that could trigger the GSTT in addition to the Estate Tax and/or Gift Tax.


Similar to the combined exemption from the Estate Tax and Gift Tax, as of 2017, each person has a lifetime exemption from the GSTT of $5.49 million.  Unlike the Estate Tax, however, a deceased souse’s GSTT exemption amount cannot be added to the GSTT exemption amount of the surviving spouse, but it can be allocated to a revocable or irrevocable trust to shelter all subsequent appreciation in that trust from any future GSTT liability.  Like the Estate Tax, the GSTT only affects a very small percentage of United States taxpayers.
Income Tax and Capital Gains Tax

A property owner’s basis in highly appreciated assets can be an important consideration in estate planning.  Generally, a property owner’s basis in an asset is equal to the price the owner originally paid to acquire the asset.  If the owner of an appreciated asset decides to sell it during the owner’s life, the owner would need to pay Capital Gains Tax on the appreciated value of the asset.  The Federal Capital Gains Tax is imposed at a maximum rate of 20%.
If the owner of the asset gifted it to another person during the owner’s life, then the recipient of the gift would have the same basis and would likewise need to pay the Capital Gains Tax on the appreciated value of the asset if the recipient sold it after receiving the gift.  This is known as “carryover basis” – where the recipient of a gift simply adopts the original owner’s basis in an asset.  

If, however, the owner of the appreciated asset leaves it to another person upon the owner’s death, then under current tax law, the recipient’s basis in the appreciated asset would be adjusted to the asset’s fair market value on the date of the owner’s death – this is known as a “step-up” in basis.  With a step-up in basis, the recipient of an inherited asset could subsequently sell the asset with little or no Capital Gains Tax liability resulting from the sale.
It is important to note that upon the death of a deceased spouse, the surviving spouse who owned property with the deceased spouse as Community Property will receive a full step-up in basis for the entire value of the property.  On the other hand, if the spouses owned the property merely as Joint Tenants, then the surviving spouse would be entitled to a full step-up in basis for only half of the total value of the property.  

Spouses owning their primary residence as Joint Tenants is a fairly common occurrence, and can have significant adverse Capital Gains Tax consequences for the surviving spouse who, for financial reasons, must sell the home after the death of the deceased spouse.  It may be prudent to seek professional assistance to ensure the correct preparation, execution, and recordation of documents transferring or changing the form of co-ownership of real estate or other property.

Property Tax
In California, generally, transfers of real property may result in the property being reassessed for purposes of increasing the amount of ongoing Property Tax owed by the property owner. Property Taxes can vary from county to county and city to city, but they are usually imposed at a total annual rate (state and local taxes combined) of around 1.25% on the value of each real estate property.

The amount of the Property Tax is generally based on the fair market value of the property on the date of each change in ownership.  Consider this example:  John bought his Silicon Valley Home for a fair market value of $20,000 in 1968.  In 2017, John sold or gifted his home to his best friend, Joseph, when John’s home had a fair market value of $2,500,000.  After receiving title to the home from John, instead of paying John’s annual property taxes on the home of $250 (1.25% of $20,000), Joseph will now be paying $31,250 each year in property taxes (1.25% of $2,500,000).  If Joseph cannot afford to pay this tax bill, then he effectively cannot afford to own John’s house, which can often be the case in the event that a highly appreciated real estate asset is transferred as a gift.

Fortunately for some owners of highly appreciated real property, there are a few exemptions that can prevent a property from being reassessed for property tax purposes.  For example, transfers of a principal residence to the owner’s children, spouse, or revocable trust created for the benefit of the owner and/or the owner’s spouse are generally exempt from property tax reassessment.  Special forms may need to be filed with the appropriate government agency in order to claim these exemptions and it may be best for the owner to use particular language in the real estate transfer documents or deeds to ensure that the transfer is correctly characterized as being exempt from reassessment.  Avoiding reassessment of real property can be very complicated and require strict compliance with filing deadlines and information reporting rules, and thus may require a skilled professional to ensure that the transfer of real property is correctly executed.