What are the Estate and Gift Tax Exemptions for 2024?

Unless Congress acts, regulations that elevated exemptions will expire at the end of 2025, and the federal estate and gift tax exemption will be cut by about half, says the article “Take Advantage Of Increased Gift And Estate Tax Exclusions in 2024” from mondaq.

Those whom the gift and estate tax may impact should speak with their estate planning attorney about using this historically high exemption. Many estate planning strategies can be used to transfer wealth and take advantage of these exemptions efficiently.  I’ve covered this a few times as we approach the exemption, so see here for some ideas:  https://galligan-law.com/gifting-and-estate-taxes/  

In November 2023, the IRS announced increases for gift and estate tax exemptions in 2024, including an increase in the federal gift, estate, and GST (Generation Skipping Tax) exemption and the annual exclusion from gift tax. These changes became effective on January 1, 2024.

The gift and estate tax exemption has increased to $13,610,000 per individual in 2024. If they make good use of a portability election, a married couple could pass $27,220,000 of property. This marks a substantial increase of $690,000 per person ($1,380,000 per married couple) from the prior year.

Generally, gift and estate taxes may be due if a person’s total wealth transfer during their lifetime and at their death exceeds the gift and estate tax exemption, which is why gifting strategies may come into play as we head into next year.

The GST tax exemption increased to $13,610,000 per person in 2024. This tax may be triggered by transfers to or in trust for family members more than one generation younger than the donor. It might also be triggered by gifts to unrelated individuals who are 37.5 years younger than the donor.

The annual gift tax exclusion increased to $18,000 per donor, per gift recipient, and $36,000 per married couple splitting gifts. The annual gift tax exclusion permits individuals to make gifts to any amount of people tax-free every year without being counted against their lifetime gift and estate tax exemption.

An experienced estate planning attorney will explain the time-sensitive opportunities presented by the increases in 2024 in conjunction with the current (yet temporary) exemptions.

Now is the time to consider funding trusts with assets expected to have high growth potential, using a portion of the gift tax exemption while removing future appreciation from the estate.

Reference: mondaq (Dec. 21, 2023) “Take Advantage Of Increased Gift And Estate Tax Exclusions in 2024”

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What Is the Step-Up in Basis?

Many clients are concerned about taxes in their estates.  Some people are concerned with federal estate taxes, although those rules don’t affect too many people.  Capital gains tax and the “step-up” in basis rule apply to almost everyone, and so it is important for clients to be familiar with this rule.

The “step-up” is tax rule which changes the cost basis of an inherited asset, including stocks or property, to its value as of the date of death.   As a result, the beneficiary may receive a reduction in the capital gains tax they must pay on the inherited assets. For others, according to the recent article, “What Is Step-Up In Basis?” from Forbes, it allows families to avoid paying what would be a normal share in capital gains taxes by passing assets across generations. Estate planning attorneys often incorporate this into estate plans for their clients to minimize taxes and protect assets.

Here’s how it works.

If someone sells an inherited asset, a step-up in basis may protect them from higher capital gains taxes. A capital gains tax occurs when an asset is sold for more than it originally cost (subject to some other provisions we won’t worry about here). A step-up in basis considers the asset’s fair market value when it was inherited versus when it was first acquired. This means there has been a “step-up” from the original value to the current market value.

Assets held for generations and passed from original owners to heirs are never subject to capital gains taxes, if the assets are never sold. However, if the heir decides to sell the asset, any tax is assessed on the new value, meaning only the appreciation after the asset had been inherited would face capital gains tax.

For example, Michael buys 200 shares of ABC Company stock at $50 a share. Jasmine inherits the stock after Michael’s death. The stock’s price is valued at $70 a share by then. When Jasmine decides to sell the shares five years after inheriting them, the stock is valued at $90 a share.

Without the step-up in basis, Jasmine would have to pay capital gains taxes on the $40 per share difference between the price originally paid for the stock ($50) and the sale price of $90 per share.

An extremely common example of this is the primary residence.  Clients who live in their home for 40 plus shares may have purchased it for $20,000, only to have it be worth $350,000 now.  Absent the step-up in basis, the beneficiaries might sell the residence after mom dies and would pay capital gains tax on $330,000 worth of growth.  With the step-up in basis, they would sell it for its then present value of $350,000, have a cost basis of $350,000, and therefore no gain on which to pay tax.

Other assets falling under the step-up provision include artwork, collectibles, bank accounts, businesses, stocks, bonds, investment accounts, real estate and personal property, including assets held in a revocable trust. Assets not affected by the step-up rule are retirement accounts, including 401(k)s, IRAs, pensions and most assets in irrevocable trusts.  Cash also has no cost basis, and therefore no step-up.

Now, clients commonly want to make gifts of property.  Giving a gift during lifetime means the original owner does not have the asset at their deaths, and so no there is step-up in basis.  With gifting, the recipient retains the basis of the person who made the gift—known as “carryover basis.” Under this basis, capital gains on a gifted asset are calculated using the asset’s acquisition price.

Say Michael gave Jasmine five shares of ABC Company stock when it was priced at $75 a share. The carryover basis is $375 for all five stocks. Then Jasmine decides to sell the five shares of stock for $150 each, for $750. According to the carryover basis, Jasmine would have a taxable gain of $375 ($750 in sale proceeds subtracted by the $375 carryover basis = $375).

Taking my real estate example, mom decides to transfer the house to two of her children.  She gifts them the property with her $20,000 cost basis, and when they sell the property (pre or post her death), they will be responsible for the capital gains on the $330,000 worth of growth.  I have met many clients over the years who have done this on their own without the advice of an attorney, ironically on the belief they are avoiding taxes.

It is worth noting one other issue.  People refer to it as the step-up because it almost typically is an increase in cost basis.  Inflation makes the present value of assets much more than it was 40 years ago let’s say, but it is possible to have a step-down in basis.  You see this more with stock where an individual bought and sold recently, and then passed in a down market.   On the whole this rule is very taxpayer friendly, but doesn’t have to be in every case.

In summary, the step-up in basis is a powerful tool for managing capital gains tax for beneficiaries, and should be utilized in most estates.

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Can a 529 Plan Help with Estate Planning?

Parents and grandparents use 529 education savings plans to help with the cost of college expenses. However, they are also a good tool for estate planning, according to a recent article, “Reap The Recently-Created Planning Advantages Of 529 Plans” from Forbes.

There’s no federal income tax deduction for contributions to a 529 account. However, 35 states provide a state income tax benefit—a credit or deduction—for contributions, as long as the account is in the state’s plan. Six of those 35 states provide income tax benefits for contributions to any 529 plan, regardless of the state it’s based in.

Contributions also receive federal estate and gift tax benefits. A contribution qualifies for the annual gift tax exclusion, which is $16,000 per beneficiary for gifts made in 2022. Making a contribution up to this amount avoids gift taxes and, even better, doesn’t reduce your lifetime estate and gift tax exemption amount.

Benefits don’t stop there. If it works with the rest of your estate and tax planning, in one year, you can use up to five years’ worth of annual gift tax exclusions with 529 contributions. You may contribute up to $80,000 per beneficiary without triggering gift taxes or reducing your lifetime exemption.  Keep in mind that you are just making a lump sum gift, so gifting in the next 4 years to that 529 beneficiary is taxable.

You can, of course, make smaller amounts without incurring gift taxes. However, if this size gift works with your estate plan, you can choose to use the annual exclusion for a grandchild for the next five years. Making this move can remove a significant amount from your estate for federal estate tax purposes.

While the money is out of your estate, you still maintain some control over it. You choose among the investment options offered by the 529 plan. You also have the ability to change the beneficiary of the account to another family member or even to yourself, if it will be used for qualified educational purposes.

The money can be withdrawn from a 529 account if it is needed or if it becomes clear the beneficiary won’t use it for educational purposes. The accumulated income and gains will be taxed and subject to a 10% penalty but the original contribution is not taxed or penalized. It may be better to change the beneficiary if another family member is more likely to need it.

As long as they remain in the account, investment income and gains earned compound tax free. Distributions are also tax free, as long as they are used to pay for qualified education expenses.

In recent years, the definition of qualified educational expenses has changed. When these accounts were first created, many did not permit money to be spent on computers and internet fees. Today, they can be used for computers, room, and board, required books and supplies, tuition and most fees.  They have become fairly expensive.

The most recent expansion is that 529 accounts can be used to pay for a certain amount of student debt. However, if it is used to pay interest on a loan, the interest is not tax deductible.

Finally, a 2021 law made it possible for a grandparent to set up a 529 account for a grandchild and distributions from the 529 account are not counted as income to the grandchild. This is important when students are applying for financial aid; before this law changed, the funds in the 529 accounts would reduce the student’s likelihood of getting financial aid.

If you want to explore more ideas on how to pay for a loved one’s education, see this article:  https://galligan-law.com/how-grandparents-can-help-pay-for-college/  

As a quick aside, contributions to a 529 plan for a child or grandchild are also exempt as transfers under Medicaid.  This means that if you are in a spenddown situation trying to become eligible for Medicaid, contributions to this fund might be very attractive.

Two factors to consider: which state’s 529 is most advantageous to you and how it can be used as part of your estate plan.

Reference: Forbes (Oct. 27, 2022) “Reap The Recently-Created Planning Advantages Of 529 Plans”

 

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