The “Basis” for Good Planning: Using “Stepped-Up” Basis to Reduce Taxes

In recent years, it has become increasingly important to consider the income tax implications of gift giving and not just the estate tax implications.  For the majority of people, estate taxes are a non-issue due to the increase in the exclusion amount for US citizens.  However, income tax continues to impact everyone.  Therefore, an estate plan that is designed to optimize the income tax benefits to your heirs may have significantly more value than an estate plan focused solely on estate taxes.

The White House has identified the step-up in basis on capital assets as the “single largest capital gains tax loophole.”[1]  What is this loop hole you ask?  It is usually easiest to show with an example.  Imagine you have purchased stock in Google for $10,000 and over the years it has appreciated to $100,000.  If you sell that stock during your life the IRS will calculate the income taxes owed by subtracting your $10,000 basis from stock’s current fair market value of $100,000 which equals $90,000 [i.e. $100,000 – $10,000 = $90,000] of taxable income that can be taxed at a rate as high as 23.8% (or $21,420 in taxes owed).

Under this example, the capital gains taxes are more than twice as much as you originally paid for the Google stock.  Likewise, if you give that stock to your descendant while you are alive, then the recipient of that gift gets your original $10,000 basis and will have to perform the same capital gains calculation when they go to sell the asset.

By contrast, if a person dies owning that same stock there is a step-up in basis to the fair market value of the asset on the date of the owner’s death.  So if the stock is then worth $100,000 the new basis on the asset is $100,000 and the taxable income is $0.00 [i.e. $100,000 – $100,000 = $0].  With proper planning, this step-up in basis can occur again when the surviving spouse in a marriage passes providing your descendants with a second step-up in basis.

However, many older estate plans were designed to minimize estate taxes at the expense of maximizing the step-up in basis.  Accordingly, if you are holding on to older estate planning documents it is time to get in front of your estate planning attorney and make sure that your tax planning is still current in light of the changes in the tax law.

Royce Lanning

Phone: 281-367-1222

Fax: 281-210-1361

[email protected]