In the past, when the federal estate tax threshold was $1MM, most estate planners concentrated on reducing or eliminating the estate taxes. The goal was to transfer out of the estate as soon as possible.

Today’s estate tax threshold: Today, the individual federal estate tax threshold is $5.4MM. The New York State estate threshold is $3MM (and set to rise until 2019, when it will reach the federal threshold). For a couple, no federal estate taxes are anticipated until the estate reaches $10.8MM. As a result, for the vast majority of people, the focus has shifted to reducing income taxes.

Maximizing step up: In order to reduce income taxes, a plan has to be devised which maximizes the step up in basis (and avoids a step-down in basis). An outright transfer to an irrevocable trust takes out an asset from the estate (thus eliminating the future estate taxes), but at the same time this transfer may prevent an income tax benefit upon death.  The dilemma is whether to transfer the asset outright, to transfer it to a trust while retaining some indicia of ownership (thus retaining the asset in the estate), or to keep the asset in one’s name outright.

Example: Suppose you bought a building 10 years ago for $200,000. The building is currently worth $1.5MM. At the time of your demise, the building will likely be worth $3MM.

  • If the building will be retained in your estate, there will likely not be any estate taxes or capital gains taxes for your heirs.

  • If the building is transferred out of your estate during your life and later sold for $3MM by your heirs, they will likely have to pay federal capital gains taxes at 20% of $560,000.  Furthermore, New York State has a capital gains tax as well, with the maximum rate of 8.82%, for an additional tax of $246,960. Thus, the total taxes that will need to be paid by the heirs in New York on this property will be approximately $806,960!

There are methods of modifying trusts under the New York State law, even if the trusts are irrevocable. Your trust may need to be modified or decanted, in order to take advantage of the favorable income tax treatment achieved through the step up in basis.

Disclaimer: This article only offers general information.  Each situation is unique. It is always helpful to talk to a specialized attorney, to figure out your various options and ramifications of actions.  As every case has subtle differences, please do not use this article for legal advice. Only a signed engagement letter will create an attorney-client relationship.