When we think of taxes, sales or income tax is what usually comes to mind. But capital gains and estate taxes are in the news a lot these days as the current administration seeks ways of paying for top dollar initiatives such as infrastructure, social services and expanded health care. Estate planners may be wise to review their portfolios in the near future.
To realize a proposed $4 trillion tax plan, the usual targets, taxes on capital gains and qualified dividends at income tax rates of 39.6% or higher, will likely go up again. However, the big estate tax hike that people don’t hear as much about involves changing how income is taxed on unrealized capital gains at death.
Briefly, there is likely to be a repeal of the current step-up in basis for inherited assets. Currently, the law increases the tax basis for inherited assets to full fair market value upon death, which allows the passing on of appreciated assets at current market value. When the inherited asset is sold capital gains will apply only to an increase in value from its adjusted value, not its original value.
As this would apply to an inherited business, a stepped-up basis on death for income will in effect tax an asset’s unrealized appreciation to transfer. That means that if the children who inherited stock in the family business hoped to sell the business, they will be taxed on the unrealized gain at death, whether or not they decide to sell.
Taking advantage of current tax laws
For Illinois residents, it helps to understand how current federal and state laws will affect estate plans. Under the federal tax law of 2017, the estate tax inclusion went up from $5,450,000 to $11,400,000, which is doubled for married couples at $22,800,000. Because this tax exemption is portable, it is transferable to a spouse so that the spouse may pass property on to heirs debt-free.
However, Illinois estate tax is not automatically portable between spouses. When one spouse dies, all wealth transfers to the surviving spouse tax-free. But when the second spouse dies, the estate can only use one spouse’s exemption.
Many Illinois couples set up trusts in order to circumvent this tax burden, and assets transferred to a dynasty trust will avoid gift and estate taxes altogether. Some estate planners use some of their exemptions to make tax-free lifetime gifts.
Because exemption taxes change often, it is wise to plan so that you can protect your property and assets. Examining the tax implications of your estate plan can help you stay one step ahead of these changes.