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Estate Planning

The official Frantz, McConnell, and Seymour, LLP blog.

Don't Forget Income Tax Planning When Drafting Your Estate Plan

Because of Tennessee’s repeal of the State Gift Tax and the pending repeal of the State Inheritance Tax after January 1, 2016, you may have overlooked tax planning opportunities that exist in your current estate plan. 

A resident of Tennessee, or any other state, must still keep in mind and plan for the fact that our federal government’s Gift and Estate tax still remain in play.  For gifts made in 2015, a gift tax return [Form 709] is required for certain gifts exceeding $14,000 annually ($28,000 for a married couple that elects to split gifts).  For individuals passing in 2015, the federal estate tax exclusion amount has increased to $5.43 million.  But keep in mind that income tax planning is essential for estates of any size.  

If you are planning to make substantial gifts as part of your Estate plan, your beneficiaries will appreciate you considering their future income tax consequences.  Here is a simple example:

John Doe has an estate valued at less than the $5.43 million federal exclusion, which includes undeveloped real estate (a 100 acre parcel of land) purchased by Mr. Doe in 1980 for $100,000 that is now worth $500,000.  As part of his Estate planning, Mr. Doe wants to make a present gift to his adult child of either $500,000 in cash or the land worth $500,000.  What would be the tax consequences of either gift in this example?

ANSWER: A present Gift of Cash would result in no income tax consequences to the Beneficiary, but a Federal Gift Tax Return would have to be filed to report the gift (no tax would be due by either Mr. Doe or his beneficiary unless Mr. Doe had made previous gifts valued in the millions of dollars).  

A present gift of the appreciated land, on the other hand, would result in significant income taxes owed by the Beneficiary when the land is sold (and a Federal Gift Tax Return would be required, just the same as in the Gift of cash described above).  Simple estate planning can avoid the income tax consequences, considering the following.

In this simplified example, Mr. Doe would be doing a disservice to his Beneficiary if he chose to make a present gift of the land because such a gift would not allow the beneficiary to take advantage of the “step-up” in basis available for assets transferred at death.  By transferring/gifting the land prior to death, Mr. Doe’s Beneficiary would likely be stuck with Mr. Doe’s basis in the land (the $100,000 purchase price), and would be subject to income taxes on the $400,000 gain on the sale ($500,000 less $100,000 basis) of the land.  If Mr. Doe had waited to transfer the land at his death, Doe’s beneficiary would enjoy a step-up in basis to the $500,000 fair market value on Doe’s date of death and Doe’s beneficiary could then sell the land for $500,000 and report no taxable income from the sale.  

Be sure to consult your estate planning attorney on the tax aspects of any significant gifts or changes in your estate plan so you can minimize both your estate tax liability and even reduce the amount of income taxes your Beneficiaries will owe with respect to transferred (or inherited) assets.

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