The Focus of Estate Planning After the Election

The 2024 elections are over and so is much uncertainty about estate planning.

It’s now very likely the current lifetime estate and gift tax exemption amount won’t be allowed to expire after 2025. Estate and gift taxes should remain a concern for fewer than 1% of families.

But don’t think that means estate planning isn’t necessary for most people. It is.

Tax issues still should be an important focus of estate planning. The difference is that estate and gift taxes aren’t the concern for most.

Income and capital gains taxes are paramount.

A family’s after-tax wealth over a couple of generations can be increased by using estate planning techniques that reduce income and capital gains taxes. Income taxes should be a prime consideration when deciding the amount of lifetime gifts to make, which assets to give, and which assets to retain. A family’s aggregate income and capital gains tax situation also should be reviewed before selling assets.

Many people don’t consider these issues and inadvertently increase the family’s tax burden. Depending on your goals, it can be better to make lifetime gifts of property instead of cash.

If you’re giving to provide long-term benefits, give investment property instead of writing checks. That’s because recipients are less likely to sell gifts of property to spend the proceeds, but most will spend cash gifts instead of investing them.

Giving investment property also can shift income and gains from your income tax return to the returns of other family members, preferably those in lower tax brackets.

Property gifts carry tax characteristics and potential tax bills. The choices of property to give can either maximize a family’s after-tax wealth or trigger unnecessary tax increases. (In this discussion, I discuss gifts to loved ones, not to charities.)

Here are the key principles to follow.

• Be hesitant to give property with significant capital gains. Sometimes giving highly appreciated property to a loved one is a smart move. When it’s time to sell the property and the loved one will be in the 0% capital gains tax bracket or a bracket that’s lower than yours, it’s profitable to make a gift of the property and let the recipient sell it.

But there are other considerations.

The gain could be significant enough to push the recipient into a higher capital gains tax bracket and a higher overall income tax bracket, triggering higher taxes on all the person’s income.

More importantly, if there’s not an urgent reason to sell the property, remember that you can ensure a 0% capital gains tax by holding the investment for the rest of your life.

When property is inherited, the beneficiaries increase the tax basis to its fair market value on the date the previous owner passed away. The beneficiaries can sell the property right away and not owe capital gains taxes.

All the appreciation that occurred during your holding period escapes capital gains taxes. In 2021, there was a movement in Congress to repeal that step-up in basis for inherited property. But the proposals lost momentum and are unlikely to regain it now.

Capital gains are taxed at 0% when investments in taxable accounts are held for life. You might want to consider lifetime gifts of highly appreciated property when the investment fundamentals indicate it is time to sell the asset and you can give it to someone in a lower capital gains tax bracket. But when continuing to hold the investment is a good idea, look for other assets to give.

• Don’t give investment property with paper losses. In most cases, when you make a gift of property the recipient takes the same tax basis in the property that you had, as we just reviewed. The appreciation that occurred during your holding period is taxed when the gift recipient sells the property.

But when the property didn’t appreciate while you held it, someone who receives the property as a gift will take a tax basis of the lower than your basis and current market value.

So, when the investment loses value during your holding period, someone who receives it as a gift has to reduce the basis to the current fair market value. No one deducts the loss that occurred while you held the property

It’s better for you to hold the property that lost value until it appreciates. Or you should sell the investment so you can deduct the loss on your tax return.

After selling, you can either reinvest the sale proceeds in something more profitable or make a cash gift of them.

• Give appreciated investment property during a price decline. You can give more shares of a stock or mutual fund by making the gift after the price has dropped.

This strategy makes maximum use of the annual gift tax exclusion and minimizes use of your lifetime estate and gift tax exemption.

For example, when shares of a mutual fund are at $60, you could use the annual gift tax exclusion of $19,000 in 2025 to give 316.67 shares tax free. After the price declines to $50, however, you could give 380 shares without exceeding the exclusion limit.

When the investment’s price recovers, the gift recipient will have more wealth. Thanks to wise timing of the gift, that wealth was transferred within the limit of the annual gift tax exclusion and without using any of your lifetime estate and gift tax exemption.

That’s an example of why you shouldn’t focus on tax planning and family gift giving only at the end of the year.

Determine early in the year the amount you want to give, and then look for a good time during the year to maximize the tax-free value of the gifts. A decline in an investment’s price that appears to be temporary is a good opportunity to make gifts.

• Give property you expect to appreciate. A primary reason to make lifetime gifts is to remove future appreciation from your estate by transferring it to your children or other loved ones. This maximizes use of the annual gift tax exclusion and lifetime estate and gift tax exemption. It also minimizes your lifetime income and capital gains taxes.

Giving property that appreciates also maximizes the wealth of your loved ones. So, when you have a choice, give property that hasn’t appreciated a lot yet but that you believe will appreciate.

This strategy is especially valuable when the beneficiary is in a lower tax bracket than you. When the property eventually is sold, the beneficiary will pay capital gains taxes on the appreciation at a lower rate than you would have.

• Give income-producing assets. Consider the income tax brackets of different family members when deciding which assets to give. A good strategy is to give income-producing property to family members in lower income tax brackets than yours.

Suppose you own investments in taxable accounts that generate income each year, but you don’t need all that income to cover your spending. You pay taxes on that income each year. It might be pushing you into a higher tax bracket or increasing some of the Stealth Taxes, such as the tax on Social Security benefits or the Medicare premium surtax.

Consider giving some of those income-producing assets to others in the family, especially those in lower income-tax brackets.

That reduces taxes on the income, increasing the family’s after-tax wealth. In addition, the recipient is less likely to sell the asset when it’s generating income each year.

Remember that youngsters ages 19 or under (or under 24 if full-time college students) are subject to the Kiddie Tax, imposing their parents’ highest tax rate on investment income they earn above a certain amount, which is $1,350 in 2025. At that point, gifts of income-producing property might not produce income tax benefits.

I often hear from parents and grandparents who are concerned that leaving their children a lot of money will ruin them. Annual gifts are a good way to see if that’s true and even prevent it. Regular gifts help the following generations to become used to handling wealth. Large inheritances can ruin heirs who don’t have the experience of managing wealth or aren’t mentally and emotionally prepared.

Sudden wealth tends to cause problems for them. Lifetime gifts can reduce sudden-wealth syndrome.

These are the key income and capital gains tax issues that should be the focus of many estate plans today.

Remember that estate planning also should consider non-tax issues, such as asset protection, preserving your quality of life, the smooth transfer of estate management, avoiding probate, and more, as I’ve discussed in past issues of Retirement Watch.