Estate and gift tax planning were among the areas of tax law impacted by the 2017 Tax Cuts and Jobs Act which took effect in 2018. The federal law effectively doubled the lifetime exemption amount from $5.46 million per individual to $11.4 million for 2019, and $11.58 million for 2020, and also applies to the amount you can gift someone. The change is temporary, though, and goes back to 2017 levels in 2026 (adjusted for inflation).
(Most states have no estate tax, which is levied on the estate itself, and no inheritance tax, which is assessed on people who receive an inheritance from an estate.)
A big issue this year for estate planners is what they call the “basis equal to fair market value” rule, which was established in 1921. Rutgers School of Business Professor Jay Soled says the tax basis for all of a dead person’s assets become equal to the fair market value of those assets. So if you bought Tesla stock at $50, but it’s now worth $500, the recipient of the shares (upon your death) would have a $500 tax basis – which means, assuming they sold the shares shortly after your death, they wouldn’t have to pay capital gains tax on those profits. But had such shares been gifted, a so-called carryover basis rule applies, and the recipient would have a $50 tax basis in the Tesla shares, says Soled, and they’d end up paying a lot more in capital gains taxes if they sell those Tesla shares.
In other words, an asset you gift while alive may be subject to taxes you can avoid if you bequeath the same asset after death. The fair market value at time of the transfer determines the tax basis the IRS uses to figure what it can tax. In the Tesla example, the tax basis on the gift is lower than the tax basis on the inheritance, making the gift potentially subject to more in taxes.
“So in many instances, because the exemption...is so high, it’s $11,580,000, many people would be well advised to retain those shares and bequeath them instead of gifting them, so that they are able to capitalize on the basis equal to fair market value rule,” says Soled.
But there is no guarantee the basis equal to fair market value rule will be around in the future. “Joe Biden said that he would consider paying for community college by repealing code section 1014, which is the basis equal to fair market value rule,” Soled says. Death and taxes may be certain, but code 1014 may not be.
Adam Shapiro is co-anchor of “On the Move” at Yahoo Finance.
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