This Estate Planning Mistake Could Cost Thousands

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Jan 01, 2021

While you may never need to worry about forking over an estate tax payment to the federal government, there is a financial trap hidden within your estate that could bite you big time.

Spend a few minutes with the following example to see where you could get tripped up by a simple mistake that could cost you thousands.

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A relevant example

Assume you purchased shares of stock in 1981 for $1,000. Now, 40 years later you decide to pass your shares of stock, which are now worth $10,000, to your child. But when is the best time to transfer your stock shares to your child? Here are your two choices:

  • Transfer the stock as a gift while you are still alive. If you transfer the stock shares while you are alive, the stock’s original value of $1,000 also transfers to your child. If your child decides to sell the shares, your child will owe nearly $2,000 in taxes on the $9,000 gain ($10,000 value in 2021 less the original value of $1,000).
  • After you die as an inheritance. If you transfer the stock shares to your child after you die, the stock’s original value of $1,000 gets bumped up to $10,000 before getting passed to your child. If your child then decides to sell the inherited shares, your child will not owe any taxes ($10,000 value at date of your death, less the original value, which is now $10,000). In the tax world, bumping an asset's original value up to its fair market value is called a step-up in basis.

In this example, gifting the stock while you are still alive would cost your child nearly $2,000 in federal taxes.

What you can do

  • Use caution when gifting appreciating assets while you are alive. As illustrated in the above example, gifting appreciating assets to others while you are alive could leave the gift recipient with thousands in taxes.
    What to consider: If possible, consider gifting cash while you are alive and save the transfer of appreciating assets until after you die.
  • Avoid joint ownership with your children. If you co-own an asset with one or more of your children, your children will not get the benefit of getting the original value of the asset bumped up to the asset’s fair market value when you die. Co-owning assets could cost your children thousands in taxes.
    What to consider: Own appreciated assets outright while you are alive and name your children as beneficiaries in your will.
  • It is often not that simple. If you are considering a gift of appreciated stock, you will want to ensure you own it more than one year. This ensures a lower capital gains tax treatment. In addition, you need to consider gift giving reporting requirements. If you do give stock as a gift in 2021, you will have to file a gift tax return if the fair market value of the stock is more than $15,000.
    What to consider: Do the tax math for your child and the gift reporting calculation. If you think the stock will continue to appreciate and your child will own the stock for a number of years, it may still be an option to consider.

Effective estate tax planning can get complicated. Do not hesitate to call if you have questions. Our accountants can be reached in Cedar Rapids at 319-364-2945, or in Iowa City at 319-339-4884. We can meet via Zoom, conference call, or if necessary, in-person at either office.

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