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Estate Planning – Now More Complicated than Ever Even for “Non-Taxable” Estates

If you consulted with an estate planning lawyer at any time prior to 2010, more likely than not, your discussion of taxes focused firstly on how to avoid the Federal and state estate and gift taxes and secondly on income and capital gains taxes.   Due to recent changes to the US tax code, for the many more clients with non-taxable estates, estate planning attorneys now focus on how to position client’s estates to reduce the impact of income and capital gains taxes on heirs. 

Such discussions can in fact be more complex than a discussion of Federal estate and gift taxes.  Whereas a discussion of the Federal transfer taxes focuses on the whole value of an estate, a discussion of income and capital gains taxes must address the estate, asset by asset, and explore the inclusion of terms in estate planning documents to permit executors and trustees to address heirs’ different tax positions. 


At the end of 2012, the American Taxpayer Relief Act[1] made “permanent” the individual exemption from the Federal Estate Tax of $5,000,000 of a decedent’s assets (indexed for inflation), and authorized the sharing of that individual exemption between spouses. Thus, today far fewer estates are subject to the Federal estate or gift tax than ever before.  In fact, a Congressional Research Service Report[2] issued in 2013 predicted that only 0.2% of all estates of decedents in that year would be subject to estate tax.  Also, the current highest marginal Federal estate tax rate is 40%.  Thus, taxable estates are paying a top rate of Federal estate tax that is lower than at any time in the last 15 years.

In contrast, changes to Federal income and capital gains rates have moved in the opposite direction.  The “Taxpayer Relief” Act of 2012 raised the highest marginal income tax rate to 39.6% from 35% in 2012 and the highest marginal long-term capital gains and qualified dividend rate to 20% from 15% in 2012.  It also eliminated numerous tax benefits, and reintroduced the phase-out of personal and itemized deductions, for high-income individuals.  The last change in income tax rates was in 2003.

Also, The Patient Protection and Affordable Health Care Act[3] and the Health Care and Education Reconciliation Act[4], both passed in March 2010, added a 3.8% surtax on top of that.  The result - a combined 43.3% top marginal income tax rate and a combined top marginal long term capital gains and qualified dividend rate of 24%.  Add to that, Idaho’s highest marginal income tax rate of 7.4% and, estate tax concerns can pale for certain individuals in the face of income and capital gains tax concerns.

Furthermore, regarding tax on income retained in a trust rather than paid out to beneficiaries, the highest marginal Federal income tax rate of 39.6% and long term capital gains and qualified dividends tax rate of 20% are reached as soon as a trust retains $12,150 (in 2014) or more of taxable income rather than distributing it.  Also, the 3.8% surtax is imposed on its retained net investment income, the identification of which is subject to complicated rules, generated in excess of this amount.[5]  And finally, Idaho’s highest marginal trust income tax rate is 7.4% on all amounts above $10,350.

Therefore, who or what owns an asset, and the tax cost basis of that asset, has become a more important discussion between clients and their estate planning attorneys than a discussion of the estate and gift and generation skipping taxes.

Three Initial Income and Capital Gains Tax Questions For Your Estate Plan

1.  Whose Tax-Bracket Is Best?  One key to being able to retain more wealth in the family through generations is planning for whose tax bracket is best for the payment of the least tax on income generated by an asset.  For example, many people’s estate plans include establishing trusts after their death for children. These trusts are typically structured to shield the trust assets from the claims of the beneficiary children’s’ creditors and spouses (the so called “spendthrift” trusts).    However, once the trust assets are paid to a child, his or her creditors can make a claim to those assets.  In such a situation, a trustee would be motivated to retain the income in a trust until the creditor issue is resolved.  Because such retained trust income is subject to the highest marginal tax rate when it exceeds $12,150, it might make sense to amend these trusts to include your grandchildren as current beneficiaries as well as your children, so that if a child has creditor problems and the trustee does not want to make distribution to the person, at least your grandchildren can benefit from the financial legacy that you have created.  Thus, the trust will not have taxable income to the extent it is distributed to your grandchildren (although they will).

2.  What is the Tax Cost Basis of the Asset You Would like to Transfer to Children? Another key to keeping more wealth in the family is to make sure that assets gifted to your heirs during your life have a high cost basis (have depreciated in value) and assets that pass to your heirs following your death have a low cost basis (have appreciated in value).  The reason for this focus is to minimize the capital gains tax to your heirs when the asset is sold.  So for example, if you have a child who helps you run your business, do you give her an interest now during your life or upon your death?  If you give her an interest now, her cost basis for tax purposes will be your cost basis.  If you wait until your death, it will be fair market value.  However, if the value of the business today is less than what you originally paid for it, consider giving it to her now so that she will be able to use your tax cost basis in calculating capital gains tax on any sale.

 See also, our blog:

3.  Is Your Current Lifetime Gifting Plans in the Best Interest of the Total Family Wealth? If you are currently engaged in an annual gifting program of minority interests to your children in an LLC or partnership at a discounted tax cost, consider suspending those transfers until you understand the relative after-tax value to them of lifetime as compared to testamentary transfers. 


When the American Taxpayers Relief Act was signed into law on January 2, 2013, people sighed with relief that many estates would no longer be subject to estate tax so that leaving a legacy could now become the prime focus of estate planning discussions.  Unfortunately, the increase in income and capital gains taxes brought to the forefront a discussion of the effect of these taxes on the total wealth of a family.   The above three questions are just a preface to the asset by asset discussion you should have with your estate planning attorney to design a plan that is tax cost effective for all.

By Elizabeth L. Mathieu


The foregoing is NOT legal advice.  We have prepared these materials to inform and educate.  They are not, and should not be considered, legal opinions or advice to anyone, nor do they create an attorney client relationship by your reading them.  These materials may not reflect the most current legal developments in the applicable area of law.  Furthermore, this information should in no way be taken as an indication of future results.

In order to comply with the requirements of IRS Circular 230, we must inform you that any tax advise contained herein, including any attachments hereto, are not intended or written so as to be used and indeed, may not be used, by any person, including the recipient(s) and other persons who receive or read this discussion and/or any attachment hereto, for the purpose of (1) avoiding any penalty that may be imposed by the Internal Revenue Code or Internal Revenue Service or (ii) promoting, marketing or recommending to any party any tax-related matter or idea contained herein. 

© Mathieu, Ranum & Allaire, PLLC 2014


[1] P.L. 112-240, 126 Stat. 2313, enacted January 2, 2013.

[2]  The Estate and Gift Tax Provisions of the American Taxpayer Act, Gravelle, Jane, Feb. 15, 2013, p.5.

[3] P.L. 111-148, 124 Stat. 119, enacted on March 23, 2010.

[4] P.L. 111–152, 124 Stat. 1029, enacted March 30, 2010.

[5] Charitable Remainder Trusts are not subject to this surtax but are required to keep records of the net investment income they generate so that as distributions are made to the income beneficiaries, that accumulated NII is properly identified and taxed to the individual.  Note, however that there are proposed regulations that make it unclear regarding whether taxable interest or taxable capital gains distributed from the trust can be offset by the individual’s own capital losses.   Notwithstanding this confusion, however, the higher income tax rates can make this type of trust very attractive to a charitably inclined individual with highly appreciated assets.

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