Estate Planning with highly appreciated stock

May 28, 1998 - News by Hinkle Law Firm

Thursday, May 28, 1998

Wichita Business Journal – by Dan C. Peare
The 1990s have seen one of the largest — and longest — bull market rallies of all time. As a result, there are more individuals whose estates consist of large amounts of highly appreciated securities.
Because of existing estate and capital gains taxes, many people now face the possibility of paying up to 55 percent of their accumulated holdings to the Internal Revenue Service at death. Dealing with highly appreciated publicly traded stock requires special attention, not only to estate tax issues, but also to income tax issues as well.
Many individuals hold large blocks of highly appreciated stock because they do not want to sell the stock and create an instant reduction in value by the capital gains tax. Given the option, most people choose to defer the tax payments, since holding appreciated property until death will cause any capital gain to disappear.
However, there are worse things than capital gains taxes.
Large blocks of stock tend to increase the risk of loss due to a lack of diversification. With the reduction in the federal capital gains tax rate to 20 percent for long-term capital gains held for more than 18 months (as provided by the Taxpayer Relief Act of 1997), the decision to capture any gain is much easier. Now, for stockholders with a significant remaining life expectancy, gifting stock to avoid the higher estate tax is recommended, even though the capital gains tax may not be eliminated.
For elderly stockholders — or holders with a reduced life expectancy — the decision remains difficult. The death tax penalizes those persons who accumulate wealth during their life and hang onto it until death. All property that a person has possession of, control over, or an interest in is included at death in his or her taxable estate. For large estates, as much as 55 percent of the total value of all assets may be consumed by taxes.
With proper lifetime planning, however, an individual may substantially reduce, or even eliminate, the death tax. Lifetime gift-giving opportunities offer enormous tax saving possibilities.
First, every person is allowed to make annual gifts of up to $10,000 to an unlimited member of persons. If married, a couple may combine their gifts to $20,000 per donee per year. All such gifts are excluded from the gift tax and are removed from the donor’s estate for purposes of computing the death tax. In addition, the donee may be in a smaller income tax bracket, qualifying for the lower 10 percent capital gains tax rate.
Second, a lifetime gift “freezes” the value of the gift asset on the date of the gift. All future appreciation goes to the benefit of the donee with no additional transfer taxes.
Third, although the gift tax system and the estate tax system use the same tax rate schedule, the gift tax is computed on the net amount of gift the donee receives, while the estate tax is computed on the full value of all assets held by the individual’s estate on the date of death, including those assets which will themselves go to pay the estate tax.
Finally, making lifetime gifts allows a person to “pick and choose” which assets to give, and therefore, design a plan to take advantage of the single largest loophole in our transfer tax system — valuation discounts. For example, transferring marketable securities first to a limited partnership and then gifting limited partnership units may justify a substantial valuation discount from the underlying value of the assets held in the partnership.
Notwithstanding the benefits of lifetime gifting, many planners suggest that gifts of highly appreciated stock should not be made because a donee of appreciated stock takes the donor’s adjusted basis in the stock for income tax purposes. If the donor holds the stock until death, the beneficiary receives the stock with an income tax basis equal to its estate tax value. However, as the accompanying illustration shows, gifting stock during life is often better than transfers at death.
Dan C. Peare is an attorney with Hinkle, Eberhart & Elkouri LLC. He practices in the areas of estate planning and business planning. Next week: More estate planning options through the use of charitable trusts and family partnerships.