3 Tips for Tax Issues in Estate Planning

By Nick Gertsema, AIF ®

We’ve all heard the old adage about death and taxes and how they are unavoidable. We are aware our time on earth is limited and that, pending some miraculous medical breakthrough, we will all die. Ideally, that day is in the distant future, but that doesn’t mean that we don’t need to start preparing for what might happen to our estates when we pass.

When putting together financial plans, we often talk about our dreams, goals and legacies. We want to live life to the fullest. For some people, it is important to them that they set up the next generation to have more opportunities than they had. I’ve heard clients say that they want to leave money to their children, grandchildren, church, favorite charity and many other important causes and relationships.

I have never had a client tell me that they want to be sure to leave as much of their estate to taxes as possible. Talking about death is never easy, but here are a few tips on tax issues in estate planning that will help you make sure your biggest beneficiary is not the US Government.

Roth Conversions

The Tax Cuts and Jobs Act was passed and made some major changes to the standard deduction and tax brackets. We collaborated with many of our clients’ tax preparers and found that some clients have a unique opportunity for Roth conversions that could have substantial impact on the value of their estate and the amount of taxes their beneficiaries have to pay.

A traditional IRA allows deductible contributions to grow tax deferred until they are withdrawn from the account. A Roth IRA takes after-tax dollars, allows them to grow tax-deferred, and, if it meets all qualifications, the withdrawals will come out tax-free. Roth IRAs are also not subject to the required minimum distributions that traditional IRAs are subject to. They will also pass to your beneficiaries tax-free.

Roth conversion occurs when you take money from an IRA, tax it as income, and move it into a Roth IRA. Your assumption is you will be paying less in taxes now than you or your beneficiaries will pay when they take the money from the traditional IRA.

It is extremely important that your tax preparer is involved in this decision. Our tax preparers usually only know the information that we give them on an annual basis. They don’t have any idea your net worth or how much you have in qualified accounts. Typically, we pay a tax preparer to reduce our annual tax burden. In this situation, we would be increasing the current year’s tax liability to hopefully reduce future liabilities.

Harvest Tax Losses in After-Tax Accounts

An unfortunate truth of investing is that not every investment is a winner. Just because an investment is down for the year, doesn’t mean that it can’t still help your plan.

When you pass away, the investments in your non-qualified investment accounts transfer to your beneficiaries with a stepped-up cost basis. That means that when the investment transfers to your beneficiary, they receive the cost basis of the value of the investment on the date of your death.

Unfortunately, unused capital losses die with the decedent. If that investment has lost value, you can sell it to offset any capital gains in your account for that year. This means that effective end-of-year tax loss harvesting may help you offset any capital gains in your account and reduce your tax bill for the year.

Keep in mind if you have a stock that has appreciated in value by a substantial amount, it may make sense to never sell it. When you pass away, your beneficiary receives it with the cost basis of the date of your death. For example, if you bought an equity for $1 and it was worth $100 when you passed away, your beneficiary receives it with a cost basis of $100. If they sell it for $105, their capital gain is $5, not $104.

Gift Wealth While You’re Still Alive

Some clients are in a position that they are able to meet all of their spending goals comfortably and are now managing their beneficiaries’ inheritance. What could be better than knowing that you’re setting up the next generation for some financial success? The ability to watch them enjoy some of the inheritance.

In 2019, an individual can gift up to $15,000 to another person without being subject to the gift tax. A married couple can gift up to $30,000. But, beware, if you gift more than the allowed amount, the entire amount becomes taxable to the person giving the gift. Keep in mind that the current Federal Estate Tax Exemption is $11.4 million, but as recently as 2001 was only $675,000. That means that estates worth more than the exemption amount were subject to estate taxes on top of any other tax liabilities.

You’ve Worked Hard (For the Money!)

You’ve worked hard to get to where you are – it’s important that your hard-earned wealth goes where you want it to. These tips on tax issues in estate planning can be a big part of your plan, but you need to check with your financial advisor and tax preparer to see if they will work for you.

If you don’t have an updated financial plan, give us a call. We’d love to help!

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