More On Tax Planningfrom The Advisor's Professional Library
- Taxation of Real Estate Real estate may be used to shelter income and may offer certain tax benefits. However, the type of real estate investment may result in different tax treatment. Learn how to use these investments to help your clients.
- Annuities: Variable Annuities Annuities are hot. The tax rules vary with the circumstances. Advisors must be aware of these intricacies when discussing annuities with clients.
After reading many tax articles lately in various publications and even just listening to non-tax experts like my next-door neighbor, I’ve found that not only do many people believe that timing the stock market is pinpoint achievable, they also view that extreme gambling with the ever-changing tax code is never risky.
For example, a hot topic in many tax articles these days is gift taxes, relative to the inheritance tax, or estate tax, sunset coming near the end of this year. As of January 1, 2013 the tax laws sunset to 2001 levels if not extended by Congress. This will result in the inheritance tax exclusion dropping back from $5 million per person to $1 million, with the tax rate increasing from 35% to a 55% top bracket.
That said, the gift tax exclusion, which allows individuals to give away assets in 2012 up to those exclusions mentioned above with a 35% rate, could actually look beneficial if the law does sunset in 2013 to a 55% rate. However, the issue I have with most advice given on this subject is that it’s a “no brainer” and that every client should give away all their assets in 2012. Rather, there should be a comprehensive outlook advising clients on a far more complicated matter than just a 35% tax rate versus the 55% tax rate possibility in 2013.
As such, I want to make it very clear that gambling on inheritance and gift taxes is no different than the points made in my article published in early 2010 entitled, “The Gamble of a Lifetime.” The article had a slightly different subject matter relative to taxes on Roth conversions, but the nature of the gamble is the same. Almost every advisor seems to be pushing their clients to give away all their assets to heirs, and pay the gift tax now at 35%, rather than inheritance tax at 55% should they die after 2012 (assuming the law sunsets).
What I’d like to do here is touch upon a few thoughts that advisors may have not considered when discussing these issues with clients.
- Many advisors don’t have the tax expertise to consider all the possible tax scenarios in analyzing clients’ overall estate tax issues due to the differing types of assets the client may own. Assets could be classified as three types: non-qualified assets (after-tax); qualified assets (pre-tax); and tax-deferred assets (both pre-tax and after-tax combined). Advisors need to vitally understand the inner workings of each type, so I highly recommend seeking a certified public accountant and/or tax attorney to help in planning scenarios before making a blanket pitch for clients to give assets away.
- How client assets are to be disbursed does affect the future taxation of the assets once the heirs take possession, regardless of the estate or gift taxes due. I am referring to ordinary income tax (both and federal and state), as well as possible capital gains tax – which are all dependent on the type of assets in question.
If allowed to pass through the inheritance process, most IRAs are allowed to convert to an IRA-beneficiary account that doesn’t require all the income tax to be paid immediately as would be required through gifting the IRA to another person (excluding charitable gifts). Therefore, as advisors make sure you know exactly what you are recommending to clients because IRAs are a completely different animal in the gifting-versus-inheritance tax equation.
Hopefully, I’ve shed a little more light on the complexity of the gifting-versus-inheritance tax dilemma. I apologize for not hitting on all areas of concern such as the generation skipping tax.
I hope the takeaway is for advisors is to analyze clients’ situations very carefully. It’s vitally important to assess the tax recommendation risks that gift and inheritance taxes pose. However, if a client has less than $10 million in net worth ($5 million per person assuming a married couple), I believe the potential gain is not worth the risk for a mere possible 20% tax benefit spread of 35% versus 55% (assuming no later capital gains tax would be owed on any of the gifted property). In my view, that would be another “gamble of a lifetime” and not worth risking.