Estate Planning

MEMORANDUM ON ESTATE PLANNING

This is a list of frequently asked estate planning questions to help you better understand the estate planning process. While some of the answers to the questions which follow may not apply in your situation, you may find the answers to be informative nonetheless. Note that these questions and answers are tailored to those financial questions most likely to be asked by business owners. Not covered are guardianships, Medicaid planning, the actual probate process, and non-financial documents such as directive to physicians, selection of persons to make decisions, etc.

Q. I've moved to Texas from Florida, where I had a simple Will drawn with my daughter as the only beneficiary. Do I need to get a new Will made in Texas?

A. Yes, you should prepare a new Texas Will.

While it is true that Texas recognizes the validity of a Will executed in Florida, your daughter will have an easier time probating your Will if you have a new one prepared using correct Texas language.

For instance, there is almost no chance your Florida Will names your daughter to serve as the "independent executor" of your estate. In fact, she is probably called your "personal representative" which is the lingo used in Florida. Being an independent executor means she will not be supervised by the court, the preferable way to administer an estate. If you don't state in your Will that your daughter will be your "independent executor," she can still make a special request to the judge after your death asking that she be allowed to act independently, but there is no guarantee that her request will be approved.

Also, the end of your Will should have what is called a "self-proving affidavit" which is a long statement discussing the signing ceremony. Texas has its own unique form of "self-proving affidavit" and it is different from the one used in Florida. It is possible that the judge will refuse to recognize Florida's "self-proving affidavit" thereby causing your daughter unnecessary delays and expenses.

Q. My sole assets are a car, personal belongings and a savings account with less than $50,000 in it. Do I need a Will?

A. You would think there's a simple yes or no answer to your question. But as with so many other legal questions, the answer is: maybe, maybe not.

With regard to your bank account, you can set it up so that it passes to one or more persons who are named as the beneficiaries. This type of account is normally called a "payable on death" or "transfer on death" account. Most, if not all, banks allow their customers to establish this type of account.

If your estate qualifies as a small estate, but you have a Will, then your heirs can't file a Small Estate Affidavit. Instead they must take the more expensive route of probating your Will. So, depending on the expected size of your bank account, you may be doing your family a disservice by having a Will. Wills that transfer property must be probated, and in nearly all situations, that means hiring a lawyer and paying court costs and other fees.

The Small Estate Affidavit route will not be available if your savings account contains more than $50,000 upon your death. In such a case, it would be necessary to conduct a formal probate at the courthouse, and having a Will would make the probate process far, far simpler than not having one.

As far as your car is concerned, it can be transferred at death without the need for probate by completing a Form VTR-262 "Affidavit of Heirship for a Motor Vehicle." Your heirs can obtain this form at any county court annex or online at http://www.dot.state.tx.us/vtr/vtrreginfo.htm. This Affidavit will establish that the car was owned by you, and the persons who inherit your estate will need to sign it. When completing the form, your heirs might also be asked to provide other documentation such as a certificate of title, release of lien, affidavit of physical inspection, bill of sale and/or proof of liability insurance.

Your personal property does not have title, so it's not necessary to probate a Will in order to validly transfer ownership to your heirs. It's unfortunate, yet true, that personal belongings are available on a first come, first serve basis to your children, friends and neighbors. You may want to limit the number of people who have keys to your residence and also make a list of who gets what particular items. But don't forget, it's often a free-for-all following a person's death.

Note, however, that if you have minor children, my answer would be yes, you need a Will. With a Will, you could name guardians as well as a person to serve as trustee or custodian over the children's inheritance.

So, if you set your bank account up properly, if your car will be passing as you would want, and your beneficiaries are all adults, then you don't need a Will.

Once Your Will and/or Trust is Signed:

Q. Where is the best place to keep my signed original estate planning documents?

A. The best place is probably in a safe deposit box because it will protect the documents from theft, fire, accidental loss, and most other types of damage or harm. A potential problem, though, is getting it opened after your death.

If you decide to keep your estate planning documents in a safe deposit box, consider naming a family member or your Executor or trustee as a joint holder on the box. That should simplify matters following your death because someone will be able to get into the box without delay. Also, if you live in a flood zone, be sure to put the document in a water-tight plastic bag. As many shocked clients have learned, water damage caused by flooding can ruin the contents of a safe deposit box.

Another option is to keep your original estate planning documents at my office. I will hold your originals here at no charge in the locked, fire-retardant safe, but it is not as “safe” as a bank safe deposit box.. Of course, if you move, you will need to be sure to remember to provide me with your new address and phone number.

Another option with regard to a Will is to deposit it with the county clerk's office. Taking this approach can be a great idea, except that you need to be sure your records at home clearly indicate where the original can be found. Moving to a different county or changing your Will can cause problems as well.

Many people keep their original estate planning documents at home in a secure place. If you have a safe at home, that can be a good place to keep them. Be aware though, when thieves enter your home and discover a locked safe, they often take the whole safe thinking they'll find cash and jewelry. Therefore, unless your safe is bolted to the foundation of your house, it may not be the best place to keep your originals. More people than you would expect keep original Wills and other estate planning documents in an air-tight plastic bag at the bottom of their freezers. Freezers are well insulated and heavy, and have a way of withstanding fires, hurricanes, and tornadoes. Also, they don't die or move away, and they are stolen far less frequently than in-home safes.

Q. If someone's Will is in a safe deposit box at a bank when he or she dies, how do you get access to it?

A. There are three ways to get the Will out of the box.

The easiest way is if another person is named as a joint holder of the box. That person can retrieve the Will with no problems or delays.

If no other person has access to the box, Texas law allows a spouse, child, grandchild or the Executor named in the Will to examine the contents of the box while in the presence of a bank employee. If a Will is found, the bank will be required to send it to the court. Note, though, some banks will give it to your lawyer and allow that lawyer to file it with the court.

Another option is to go to court to request that a judge order an examination of the box. If a Will is found, it will be sent to the court. This should be the option of last resort because it takes longer, requires the filing of papers with the court, and usually involves a lawyer and the associated legal fees.

Q. Should I give copies of my Will and other estate planning documents to my children and to the Executors of my estate?

A. For some people, their estate planning documents are as private as their income tax returns, and nobody is ever given copies. For other people, estate planning documents are no different than a spare key to the house, and every family member and Executor and/or trustee named in the documents is given a copy.

If you are the type of person who values your privacy, who does not especially trust your children, Executor, or trustee, or if you have written a Will or trust which does not treat all the children equally, then it may not be a good idea to hand out copies. Also, you may have more money than your children expect, and depending on how your Will or trust is written, giving them a copy may be letting them know too much about your personal business.

On the other hand, if you have a fairly open relationship with all your children, you regularly discuss finances with them, and you are leaving your estate to them in equal shares, then go ahead and give everyone a copy. Of course, if you decide to change your Will or revocable trust, you should be sure to give all the same people copies of the new documents. If you don't, then there may be some arguments following your death over which document controls the disposition of your estate.

Gifts:

Q. What gifts can I make without having to pay gift taxes?

A. Every year, you can give any person you want as much as $11,000 without any gift tax consequences. This dollar amount is known as the annual exclusion, and it is now indexed for inflation. It will be increasing from time to time in $1,000 increments.

If you are married, the amount you can give to each person doubles to $22,000 since the person receiving the gift can receive $11,000 from each spouse (even though it really only comes from one). Gifts can be in the form of cash, stocks, bonds, real estate, or anything else of value. Buying real estate or bonds in the names of one or more other persons is the same as making a gift of that property to them. The value of the gift would be the amount of money you spent to buy the property or the bond.

You can also make tuition payments for any person you choose, and these payments do not count toward the $11,000 annual limit. Payments you make for medical expenses don't count against the $11,000 limit either. However, if you make a tuition or medical payment, be sure to pay the school, hospital or doctor directly, as a check made payable to a person which is used for tuition or medical care does count towards the $11,000 annual limit.

If you want to give more than $11,000 to any one person, to the extent your gifts exceed $11,000, you will use up a portion of your $1,000,000 lifetime exemption. This is the amount each person can give away without having to pay gift or estate taxes. By way of example, if you give one of your children $45,000 this year, you can exclude the first $11,000 under the annual exclusion, and the other $34,000 will leave you with a remaining lifetime exemption of $966,000.

Keep in mind that if the gifts to any person exceed $11,000 during a single calendar year, you will be required to file a gift tax return by April 15th of the following year to report the gift. That is how the IRS keeps track of how much of your $1,000,000 exemption is still available. Once you have given away more than the $1,000,000 lifetime limit, you must start paying gift taxes. In 2005, the highest estate and gift tax is 47%. However, this rate will decrease to 46% in 2006 and 45% in 2007 and will remain at 45% until 2009.

Before making large gifts, it is a good idea to talk to us, or another estate planning attorney. Once gifts are made, you can't go back and do things a better way. For instance, if you are planning to make really large gifts, then it may be wise to create trusts for the benefit of your children.

Q. What exactly are 529 accounts, and are they really as good as everyone seems to think?

A. Yes, 529 accounts are that good. In fact, they are one of the best ways--and many people think they are the best way--to save for a child's education.

You have a number of options when it comes to saving for college. There are Uniform Transfers to Minors Accounts, education IRAs, and prepaid tuition plans, to name a few. All the options have their advantages, yet in the vast majority of situations 529 accounts combine the best features of all of them to make a fairly good investment vehicle.

The main advantage is that the earnings and most withdrawals are income tax free. Even though you must use after-tax money to create the accounts, all capital gains, dividends, and interest are generally tax free. Withdrawals are subject to income taxes only when they are not used for tuition, room, board, and other authorized expenses.

The second biggest advantage is that the funds are protected from creditor claims, even though you are the person controlling the account.

Another advantage is that gifts to a 529 account not only qualify for the $11,000 annual gift tax exclusion, but you can even make five years worth of gifts today and elect to treat them as being made equally over a five year period. In other words, if a married couple with four grandchildren can give as much as $110,000 to each grandchild right now, for a total of $440,000 to the four grandchildren. Each grandchild will be treated as receiving $22,000 per year for five years.

As far as estate taxes are concerned, all amounts you contribute to the account will be excluded from your estate even though you are the person controlling the account. However, you should note that if you elect to spread your contributions over five years for gift tax purposes, and you die within that five year period, a portion of the gift will be included in your gross estate.

You can also designate a successor to yourself to control the account should you die before a grandchild goes to college.

There are a few downsides worth noting. Unlike some of the other alternatives available for saving for college, 529 accounts don't let you choose the investments yourself. All you can pick is the type of investment portfolio the account will maintain. Also, if you use funds in the account for non-qualified purposes, a 10% penalty will apply to the portion of the withdrawal which constitutes investment gains. Importantly, as well, some of the tax laws which make 529 accounts so great may expire in 2011 if Congress fails to extend the new tax laws, and other key benefits can always be changed during a future session of Congress.

Overall, 529 accounts present you with an unbeatable combination of features. The accounts offer income tax free growth and withdrawals with no gift taxes, no estate taxes, retained control of the funds, and flexibility in the future should circumstances change. The only real problem with 529 accounts is coming up with the cash needed to maximize your gifts to the accounts.

You should call your stock broker or financial planner for details on how to set up the 529 accounts.

Revocable and Irrevocable Trust Questions:

Q. For whom are living trusts most appropriate? What are the pros and cons?

A. For starters, while it is true that probate can be expensive and time-consuming in some other states, in Texas, we have a streamlined system of probate. As long as you hire a lawyer with experience in probate court, you have a well-written Will, and nobody files a lawsuit after your death, then probate is typically not so bad. Stories you read in the paper may lead you to believe otherwise. The heirs of multi-million dollar estates frequently fight it out in court for a larger inheritance. But, the probate of the estate of even a moderately wealthy person in Texas, who has left a Will doing what most Wills do, is pretty inexpensive.

Even so, living trusts can be useful estate planning tools, and they do have their place in many Texan's estate plans. The establishment of a living trust is the creation of an "entity" to which you will transfer your property, and which will therefore own that property rather than you. Because another entity rather than you owns the property is why it works. Of course, you alone or you with other(s) may be the trustee and control all decisions, and sign all papers—as trustee. If you find any one of the following benefits appealing, then a living trust may be appropriate for you.

Benefit #1: No Court Involvement. When a person dies, most properties pass either under a person's Will or under a living trust. Some properties—such as life insurance, IRAs, and certain types of bank and brokerage accounts—pass directly to named beneficiaries. If property passes under a Will, then the Will must be probated at the courthouse. Some people don't want this type of involvement with the court, so they opt for a living trust. By transferring all properties which would otherwise pass under your Will to a living trust, you can avoid the court entirely. For estates which don't owe estate taxes, there is usually less work for the lawyers, and that translates into reduced estate administration costs.

Benefit #2: Privacy. As mentioned above, when a person dies with a Will, an inventory must be filed with the court. You may not want your friends, neighbors, or the media to be able to read a listing of what you own and what it is worth. After all, an inventory is a public record. With a living trust, your properties and their values are all kept private.

Benefit #3: Plan For Future Incapacity. You may be worried that one day you won't be able to manage your own finances, and you may want to name someone to handle these types of matters for you. You can address this potential problem with a power of attorney or with a living trust. A power of attorney will usually be accepted by banks, title companies and the like, but there is always the risk that an institution's legal department will not accept it. The same person who may be denied the ability to use a power of attorney will likely be allowed to do anything he or she wants when acting as trustee of a living trust.

Benefit #4: Harder to Challenge. If you are planning to disinherit one of your children or grandchildren, you may be better off with a living trust because there is nothing filed at the courthouse. Also, it is a little harder to contest a living trust than a Will. Many people are interested in doing as much as possible to prevent a successful challenge to their estate plan.

Benefit #5: Avoid Out-of-state Probate. If you own property in another state, you can avoid a costly probate proceeding in that state by transferring the property to a living trust.

Before you establish a living trust you need to understand the downsides, which include the following:

Disadvantage #1: Time-consuming and Expensive to Set Up. Depending on how many different types of properties and accounts you own, it can take quite some time to switch everything over to the name of your living trust. Also, some financial institutions in Texas are not geared up to handle living trusts, so you can expect a little trouble and frustration in getting the trust fully established.

Disadvantage #2: Complicated. Wills are usually shorter and simpler to understand than living trusts. Also, with a Will, you can sign it and forget about it. But with a living trust, you need to put your property into the trust and run your life out of it for as long as you live. For many people, this downside outweighs all the potential benefits.

Disadvantage #3: Time-consuming to Revoke. A year after you set up the living trust, you may decide you don't want it any more. At this point, you will need to return to every bank and brokerage house, and undo everything you had done to establish the trust. You can expect more lawyers' fees too.

Disadvantage #4: Post-Death Costs Not Eliminated. If you have a taxable estate (which is generally an estate over $1,500,000 in 2005 or $2,000,000 in 2006, 2007 and 2008), there will be a lot of work to be done after death regardless of whether probate is required. Typically, there are tax returns to file, trusts to establish, assets to value, and more. Avoiding probate will only marginally reduce the cost of administering a taxable estate.

Disadvantage #5: May Still Need to Probate Will. If you leave just one bank account or one piece of real estate out of the trust, probate will still be necessary. And probate takes about as long when there is one asset as when there are twenty.

Q. What is the difference between a Living Trust and a Bypass Trust?

A. A Living Trust is a revocable trust created while a person is alive, whereas a Bypass Trust is typically an irrevocable trust created at death. A Bypass Trust can be created by a Living Trust or by a Will. (Yes, a Living Trust can create a Bypass Trust, but a Bypass Trust would never create a Living Trust.)

Normally, the person who creates a Living Trust names himself or herself as trustee and as beneficiary. Upon that person's death, all or a portion of the property which remains in the Living Trust passes according to the terms specified in the trust agreement.

Bypass Trusts are most often created when a husband or wife dies in order to save taxes when the other spouse passes away. When a married person dies and leaves everything to his or her spouse, that surviving spouse may then be too wealthy to pass everything to their beneficiaries tax free. Being "too wealthy" means the married couple is worth over $1,500,000-the estate tax exemption in 2005. The Bypass Trust is a way to shelter the first spouse's $1,500,000 exemption from taxation when the surviving spouse dies, thereby doubling the amount that can be left tax-free to $3,000,000. Remember, the estate tax exemption will be increasing over the next few years, so the maximum size of a Bypass Trust will be increasing too.

Bypass Trusts do have non-tax benefits though, and for some people, saving taxes is not the motivating factor in creating one. For instance, Bypass Trusts protect the trust property from creditors' claims, and they allow the deceased spouse to direct where the trust property passes when the other spouse dies.

There are some exceptions to the statements contained in this answer. For instance, Bypass Trusts are not always created at death. Some wealthy people create them during life, and other people use their estate tax exemptions for different purposes rather than the creation of a Bypass Trust.

Q. What are the tax advantages to setting up an irrevocable trust to own an insurance policy?

A. Although life insurance is generally not subject to income taxation upon the death of the insured, it is subject to estate taxes if the insured owns the policy (or has other ownership rights).

Owning a life insurance policy results in all or a portion of the insurance proceeds being included in the insured's estate and therefore taxed when death occurs, thereby substantially defeating the purpose of buying the life insurance.

While it is true that life insurance which is received by a spouse is not subject to estate or inheritance taxes because of the unlimited marital deduction (assuming the surviving spouse is a citizen of the United States), those same proceeds will be included in the spouse's estate later on when he or she dies. Therefore, life insurance trusts are often a good idea even when there is a surviving spouse to receive the proceeds.

Life insurance trusts offer a number of significant advantages over outright ownership. For starters, the trust will insulate the proceeds from the claims of creditors and from spouses in a divorce.

Also, life insurance trusts can be written to last for children's lifetimes and then pass without estate taxes to additional trusts for grandchildren. This is a feature commonly referred to by estate planning lawyers as "generation skipping planning." Your children shouldn't be alarmed by the words "generation skipping" because you are not skipping them. Your children can serve as trustees of their trusts, and they can be given the power to make distributions to themselves or their children according to fairly liberal standards. Normally, trusts like the ones being described would allow your children to make distributions for their health, education, maintenance and support. And your children would be the ones determining how much money it takes to maintain and support themselves. Even though the life insurance proceeds will be held in a trust, your children would not be prevented from using the trust funds.

Even if Congress and the President repeal the estate tax in the next few years, people will still create trusts because trust property never becomes commingled with other property owned during a marriage (unless your children distribute the money from the trust to themselves), and the trust funds will generally be unreachable by creditors (as long as the trust property remains unincumbered inside the trust).

Retirement Accounts and Funding a Bypass Trust:

Q. Our entire estate except for a small checking account, and a house worth about $150,000 is in my IRA account. My IRA is now worth about $1.6 million. Can my IRA be used to fund a bypass trust? What happens if we do not fund the trust and I name my wife as the beneficiary of the IRA?

A. Yes, with proper planning, an IRA can be used to fund a bypass trust.

By way of background, bypass trusts are sometimes needed because people are allowed to leave a maximum of $1,500,000 estate tax-free at death in 2005. While it is true that the $1,500,000 amount will be increasing over the next few years, it is also likely that your IRA will increase in value too. At least you hope so.

If you name your wife as the beneficiary of your IRA and you give her the rest of your estate, she will immediately be worth in excess of $1,500,000 upon your death. That dollar amount is much larger than the amount she can leave estate tax-free upon her death (assuming she dies in 2005). If your wife dies first, you would likewise then be worth in excess of $1,500,000, and upon your death, the estate tax would be the same. Certainly, you would like to do whatever you can to reduce or eliminate the estate tax. That is why bypass trusts can be useful.

Rather than give your entire estate to each other, the first spouse to die would instead place as much property as possible into a bypass trust. Typically, the surviving spouse would be in charge of the trust as trustee and would be able to distribute property as needed for health, support and maintenance. So there is no real loss of control or access to the property in the trust.

Placing real estate, cash, stocks and bonds into a bypass trust is easy, as there are generally no tax consequences when setting up the trust. However, the IRS has complicated and restrictive rules when it comes to IRAs.

The typical plan involves setting up your estate so that a portion of your IRA could be placed in the bypass trust following your death. Estate taxes would be eliminated because your wife's estate would be less than the $1,500,000 threshold (in 2005) upon her death. Even if your wife dies first, her one-half community property interest in your IRA can be sheltered within the bypass trust created in her Will, thereby saving estate taxes upon your subsequent death.

Getting the IRA into the bypass trust does have a few downsides.

Number One: In your quest to save estate taxes, your wife may get stuck paying extra income taxes. For instance, if you die first and your IRA is paid to the bypass trust, your wife may not be able to roll the entire IRA over to her own new IRA and defer income taxes until she reaches age 70 ½. Instead, with the bypass trust named as the beneficiary, distributions may need to start soon after your death, and then continue over your wife's life expectancy. If your wife is 55 years old upon your death, that means she may need to start taking distributions 15 years earlier than if she had opted for the IRA rollover.

Number Two: Your wife may not be able to name your children as beneficiaries and thereby extend the income tax deferral for their lifetimes. This option would be available if she rolled your IRA over to her own IRA.

Number Three: You may not completely eliminate estate taxes. The reason stems from the fact that you have never paid income taxes on your IRA. When the IRA is owned by a bypass trust, each time a distribution is made to the trust, income taxes must be paid. If the IRA distribution is left in the bypass trust, the tax rate will generally be equal to the highest marginal income tax bracket (in 2005, that figure is 35%). Your wife can avoid this high rate of tax by giving the IRA distributions to herself (which is allowable, and possibly even required depending on the terms of your Will or revocable trust, as she controls how much she can get from the trust). When the distributions end up in her hands, rather than the trust paying a high income tax, she pays income taxes at her own income tax rate, which may be far lower. The result over time is that the bypass trust keeps getting smaller and smaller each time your wife gives the IRA distributions to herself directly. That makes her worth more and the bypass trust worth less. And if she is worth too much at her death, then estate taxes will still be owed.

As you can see, the laws associated with IRAs and bypass trusts are extremely complicated. This answer is designed to give you a general overview of the planning options which are available, and there are exceptions to some of the statements in this answer.

Custodial Account Questions:

Q. I created a Uniform Transfers to Minors Account for my son a few years ago, and it is now worth about $80,000. My son has no idea about the account, but I know he is legally entitled to the funds when he turns 21 later this year. I realize it's not exactly legal to put the $80,000 back in my name, but I don't want him to get the funds because I have a suspicion it will be spent in a matter of weeks. Is there anything legal I can do to maintain control of the account and keep him from having full access at age 21?

A. There are two realistic options available to you.

(1) For starters, you could invest the $80,000 in a limited partnership controlled by you. When your son reaches age 21, he will not receive the $80,000, but instead will become the owner of a limited partner interest. As a limited partner, his rights can be severely restricted, thereby allowing you to control the funds for as long as the limited partnership exists. The limited partnership agreement can be written so that your son has no right to demand a distribution or veto your investment decisions.

One of the downsides to creating a limited partnership is that you are introducing a bit of complexity into your life. Many people find this type of business arrangement too complicated for their tastes. Also, the legal and filing fees to set up a limited partnership can be costly. And once the limited partnership exists, you will need to file annual income tax returns to report the partnership's income to the IRS.

Not only that, but many people create a limited liability company to serve as the limited partnership's general partner. If you choose to create this additional entity, the fees to form and maintain the limited partnership arrangement will be even higher.

A word of caution: Your son may be the type to hire a lawyer to represent his best interests. If he does, it is possible--although highly unlikely--that your son might sue you to recover any funds you have placed in a limited partnership which limits his rights. In theory, your son would have a compelling argument. After all, most people would agree that receiving $80,000 in stocks and cash is better than receiving a limited partnership interest with all the associated restrictions.

(2) Another option is to tell your son about the existence of the account, but make it clear that he would be making a huge mistake by not letting you continue to control the funds. If he puts up too big a fuss and demands the money, you can modify your estate plan and completely cut him out as a beneficiary of your estate. There is nothing illegal about you managing your son's investments for him, assuming he has the right to ask for the money at any time.

Q. I set up custodial funds in my children's names to pay their college expenses, with me as custodian. The mutual funds I invested in have done so well that the accounts far exceed what they'll need for college. Can I legally give money from these funds back to myself? If so, how?

A. No, even though there is nobody to stop you from giving the money back to yourself, doing so would be illegal. Gifts to custodial accounts are irrevocable.

Fortunately, you can start spending the money in the custodial account on things for your children which you may now be paying for out of your own funds. For instance, if one of your children wants to spend the summer studying in France or if one of your children needs a new car, use the money in the custodial account to pay for these expenses, not your own money.

Tax Question:

Q. How are stock values "stepped up" as a result of death? My father has a lot of stocks that he bought decades ago, and I'll be inheriting them when he dies.

A. Getting a stepped-up cost basis on inherited stock allows you to save taxes when the stock is sold. For instance, if your father bought a stock at $10 a share, and it is now worth $100 a share, when he sells the stock, he will owe a capital gains tax on the $90 the stock has appreciated. If your father gives you the stock before his death, the gift will be valued at $100 a share, but you will take his cost basis of $10 a share. That means you will owe a capital gains tax when you sell the stock.

If your father waits to give you the stock until after his death, the stock will be valued in his estate at $100 a share, and you will have a new cost basis of $100. Your father's $10 cost basis gets "stepped-up" to $100 as a result of his death. This is true even if your father's estate is not required to file a federal estate tax return. When you later sell the stock, you will only owe capital gains if the value of the stock is higher than $100.

If your father is married, rather than leaving the stock to you, your father might leave the stock to his wife (presumably, your mother). In that case, your father and mother would probably own the stock as community property, with each owning one-half of the stock. Upon your father's death, your mother will not only get a stepped-up cost basis on your father's one-half of the community property stock, but (windfall!) she will get a stepped-up cost basis in her half of the stock as well, as this is a benefit which is generally available only in community property states.

You can use this in your own planning. If you own $20,000 worth of stock that you purchased for $1,000 years ago, you may be hesitant to sell the stock because you don't want to pay capital gains taxes (typically 15% of $19,000, or $2,850). Your idea may be to give the stock to your father, who is very ill and near death, and then have him leave it to you when he dies, thereby getting a stepped-up cost basis. As you might expect, the IRS doesn't like this, and there is a rule which says if your father dies within one year of being given your stock, then you receive the stock with your old cost basis. If your father makes it more than a year, then you do get the stepped up cost basis.

Sterling Minor can further advise you on all of the above issues, and on other issues involving estate planning; he will meet and confer with you and your other advisors; and, he can properly prepare all the documents needed to carry out your planning.

This memorandum contains general information and while the information presented is accurate as of the date of its publication, it cannot be relied upon as legal advice, as that can only be obtained through personal consultation with an attorney with whom you share your specific facts.

Last Updated: May 16, 2005