This is part of a series of 6 blogs on important estate planning considerations. I’ll intersperse these blogs with other timely blogs.

The first article in the series showed how an estate plan prepares one for incapacity during life and not just for the distribution of assets at death. The second article in the series focused on how an estate plan should take into consideration the potential for future Long-Term Care (“LTC”) needs. The third article focused on the differing needs of the beneficiaries and the need for different planning as a result. The fourth article focused on beneficiary designations and the need for coordinating them with the overall plan. The fifth article focused on planning for retirement assets. This sixth article focuses on how taxes should be considered in planning an estate. 

When planning, taxes are an important consideration. Of course, that does not mean they are the only consideration, or even the most important consideration. That’s the reason taxes appear as the final estate planning consideration on the list. Taxes really break down into two components: taxes of the client and taxes of the beneficiaries.

Here are some important tax considerations when planning for a client:

• Estate, gift and GST taxes: Have you considered ways to eliminate or minimize these transfer taxes? Examples are freezing the value of assets through strategies such as a Grantor Retained Annuity Trust (“GRAT”) or squeezing the value of assets through discounting. Have you considered strategies to take maximum use of exclusions and deductions? For example, have you considered gifting of the client’s annual exclusion of $15,000 per person, outright or to a trust with withdrawal powers?
• Income taxes: If assets are being removed from the estate to save estate taxes, have you considered the impact of a loss of basis step-up from having the asset removed from the estate? Have you considered the impact of IRAs and 401(k)s? If the client has a period of low or no income, consider converting some or all to a Roth IRA.
• Property taxes: Consider any impact of estate planning strategies, including a revocable trust, on local property taxes.

Here are some important tax considerations for the beneficiary:

• Estate, gift and GST taxes: Have you considered how you might use GST planning to keep assets from being included in the estate of the beneficiary, while still allowing the beneficiary to use and control the funds? If the client has sufficient GST exemption, a lifetime trust for the beneficiary may be used to accomplish this. This may be particularly appealing if the beneficiary may have their own taxable estate or lives in a state with a separate estate tax.
• Income Taxes: Have you considered the impact of the beneficiaries’ income tax brackets? For example, a Roth IRA (which is income tax-free) may have significantly more value to a beneficiary in a higher income tax bracket. A traditional (income taxable) IRA may be better to leave to a beneficiary in a lower income tax bracket, because the income taxes would diminish it by less and the after-tax value would be greater.
• Property taxes: Have you considered the impact on property tax value of giving the property to different beneficiaries? Some states freeze the value of certain property for local property tax purposes. In some states, if the property is inherited by the owner’s child, the child may also keep the owner’s property tax basis. This may result in much lower property taxes on an ongoing basis. Of course, this may not matter if the beneficiary is not going to retain the property.

Taxes, both for the client and for the client’s beneficiaries, are simply one aspect to consider in planning. Taxes may be an important consideration, but many other factors, such as the well-being of the client and the beneficiaries and the achievement of the overall goals of the client are much more important.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com