The Tax Game Has Changed: From Estate Tax to Income Tax

For years, estate planners have done what is considered traditional estate planning. They drafted plans primarily concerned with minimizing future estate tax liability and gave minimal attention to income tax consequences.

This was perfectly fine years ago when the estate tax was much more severe than the potential for income tax. This was attributable to relatively high estate tax rates, low estate tax exemption that was not indexed for inflation, and comparatively low capital gains rates.

Recently, however, Congress has tinkered with the tax system in a huge way. Accordingly, the income tax impact of estate planning is taking on greater significance.

More attention is directed towards the importance of income tax basis considerations in estate planning due to the narrowing between the estate tax rates and the income tax rates. In fact, in most estates worth less than $10.5 million, estate taxes are no longer an issue. Now, income taxes loom large, primarily because of the lack of attention on the income tax basis (i.e. cost or adjusted basis) of capital assets.

The bad news for most middle-class taxpayers is that for years they’ve been fed a steady diet of estate tax minimizing wills and trusts. Worse yet, they hang onto these outdated documents for many years, thinking they are done with their estate planning and not wanting to be bothered. Sadly, these old documents will no longer serve their intended purpose: estate tax minimization. While there will be no estate tax savings with these documents, because very few middle-class taxpayers will ever pay estate tax, the documents will unnecessarily increase income taxes for their heirs upon the liquidation of any assets.

Bottom line:  the game starts anew. Let’s focus on income tax minimization for most taxpayers and forget about estate tax minimization. Unless your estate is worth $10.5 million or more as a couple (or $5.34 million as a single person), your biggest risk is overpaying income taxes due to inattention to income tax basis planning in your wills and trusts.  Don’t make that mistake. Review your documents today.