Can Estate Planning Reduce Taxes?

POSTED ON: July 28, 2022

Upstream basis planning is a trust strategy that can save wealthy people on their capital gains taxes and income taxes associated with highly appreciated assets.

Can Estate Planning Reduce Taxes?

The estate tax exemption won’t always be so high. The runup in housing prices may mean capital gains taxes become a serious issue for many people. There are solutions to be found in estate planning, including one known as an “Upstream Power of Appointment” Trust, as explained in the article “How to Use Your Estate Plan to Save on Taxes While You’re Still Alive!” from Kiplinger.

The strategy isn’t for everyone. It requires a completely trustworthy, elderly and less wealthy relative, such as a parent, aunt, or uncle, to serve as an additional trust beneficiary. First, here is some background information:

Basis: This is the amount by which a price is reduced to determine the taxable gain. This is often the historical cost of an asset, which may be adjusted for depreciation or other items. Estate planning attorneys are familiar with these terms.  Generally, if you purchased your house for $100,000, and you didn’t have any additions to the house, then your “basis” is $100,000.

Step-up (in-basis): Again, assume your bought a house for $100,000.  If you sell it for $400,000 the day before you die, your taxable gain would be $300,000. Often, this taxable gain is excluded if you are the homeowner selling your home if you meet the conditions under the Internal Revenue Code.  However, the same rule does not apply to your children.  If they were to sell the house for $400,000, they would have a taxable gain of $300,000 (because they did not own and live in the home on your date of death).  If you owned the home on your death, Section 1014 of the Internal Reveune Code, known as the “step up in basis”, works to adjust the basis from $100,000 to $400,000, the fair market value on your date of death.  In other words, with the step up your heirs woud have a new basis of $400,000 eliminating any built in capital gain.  So the benefit is that there would be no capital gain on the sale and no taxes owed.  That capital gain would be approximately $78,000, calculated as 26% X $300,000.  The 26% is the top long term federal capital gain rate plus a 6% Louisiana state income tax rate.

So even though your estate may not be subject to the estate tax, don’t be penny wise and pound foolish when it comes to your estate income tax planning.

Lifetime estate tax exemption: This is currently at $12.06 million per person or $24.12 for married couples. This is the amount of assets which can be passed to children or others free of any federal estate tax. However, the number will take a deep dive on January 1, 2026, when it reverts back to just under $6 million, adjusted for inflation. Plan for the change now, because 2026 will be here before you know it!

Upstream planning involves transferring certain appreciated assets to older or other family members with shorter life expectancies. Since the person is expected to die sooner, the basis step-up is triggered sooner. When the named person dies, you obtain a basis step-up on the asset, saving income taxes on depreciation and saving capital gains on a future sale of the property.  There are other things to consider in such planning, such as medicaid qualification.  In other words, upstream planning may disqualify the older relative from medicaid benefits, so consider such planning carefully.

Most Americans aren’t worried about paying estate taxes now, but no one wants to pay too much in income taxes or capital gains taxes.

To make this happen, your estate planning attorney will need to give an elderly person (let’s say Aunt Rose) certain ownership rights to the asset, such as a usufruct for life.  In other states, a general power of appointment would work, but Louisiana law does not recognize powers of appointment.  If the asset is included in Aunt Rose’s gross estate, then there would be a step up in basis on her death.

Don’t do this lightly, as ownership rights carry legal implications.  Can you protect yourself, if Aunt Rose goes rogue?

While the Internal Revenue Code (“IRC”) rule doesn’t require Aunt Rose to get your permission to control or change distribution of the property, a trust can be crafted with a provision to effectuate the desired result. The IRC doesn’t require Aunt Rose to know about this provision. This is why the best person for this role is someone who you know and trust without question and who understands your wishes and the desired outcome.

So the answer to the question of “Can Estate Planning Reduce Taxes?” is Yes!  Proper planning with an experienced estate planning attorney is a must for this kind of transaction. All the provisions need to be right: the beneficiary need not survive for any stated period of time, you should not lose access to the assets receiving the basis increase, you want a formula clause to prevent a basis step down if the property or asset values fall and you want to be sure that assets are not exposed to creditor claims or any other liabilities of the person holding this broad power.

BOOK A CALL with me, Ted Vicknair, Louisiana Board Certified Estate Planning and Administration Specialist, Louisiana Board Certified Tax Law Specialist, and Louisiana CPA to learn more about estate planning in Louisiana, incapacity planning, and Louisiana asset protection.

If you liked this article, “Can Estate Planning Reduce Taxes?” read also these additional articles: Addressing Property in Another State in Estate Planning and What Should I Know about Burial Insurance? and Does Potential IRS Change Have an Impact on Estate Plan? and Understanding the Issues of Elder Law

Reference: Kiplinger (July 3, 2022) “How to Use Your Estate Plan to Save on Taxes While You’re Still Alive!”

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