Benjamin Franklin said it best, “nothing in this world can be certain except for death and taxes.” That quote still holds true to this very day. No matter what the advancement in modern medicine may hold over the next 20, 40, or 60 years, one thing is certain, each one of us will eventually die. Although it is morbid to say, it is a fact of life that each one of us must realize and understand. In addition, and barring some unforeseen set of historical events in the future, there will always be taxes that we will have to pay.
In the estate planning context, this usually means being aware of the federal estate and gift tax, the Tennessee inheritance tax, and the capital gains tax. However, what should be put to rest is the misconception that your family will lose your inheritance when you die, or at least half of your inheritance, due to taxes. In actuality, not too many people will owe anything under the federal estate tax when they die. Under the current federal estate and gift tax regime, only estates with a gross value above $5.25 million will be taxed under the federal estate tax. In addition, due to portability, you can use your deceased spouse’s unused estate tax exemption to create a $10.5 million estate tax exemption. However, where the concern comes in is using the estate and gift tax exemption during your lifetime. For instance, the IRS allows you to give away or gift up to $14,000 per year without any estate gift tax ramification. However, if you gift away more than $14,000 per year, your $5.25 million estate gift tax will be reduced by that amount. For example, if you gave away a gift to your children of $20,000, you essentially gave your children a $6,000 gift for estate gift tax purposes. Therefore, your estate tax exemption would be reduced by $6,000 at your death from the federal estate tax.
Also, you need to be aware of the implications of the capital gains tax. In the simplest terms, the capital gains tax is a tax that is placed on the gain realized by the sale of a capital asset. For example, if you purchase stock in the Apple Corporation for $1,000 and you later sell that stock for $10,000, then you will be required to pay a capital gains tax on the $9,000 gain. Now, when you die and your children inherit an asset there is a step up in tax basis. Meaning, and using the example above, if you leave the $10,000 in Apple stock to your children, then your children’s tax basis would be $10,000 and not $1,000. Therefore, if your children immediately turn around and sell that stock for $10,000, then your children will not owe any capital gains tax because their tax basis was $10,000. However, if you gifted away the $10,000 in Apple stock to your children, although this does not affect your estate tax exemption at your death, it would affect your children’s tax obligation. This is because when you gift an asset to your children, there is no step up in tax basis, but there is a carry over in tax basis. This means that you children will receive your $1,000 tax basis. Now, when your children sell that $10,000 in Apple stock, your children will owe capital gain tax on the $9,000 realized gain.