Compassionate But Clinical

By: Steven Weintraub

A long-time client recently reached out to let us know that their last surviving parent was with Hospice. We were supportive emotionally and empathetic about the transition of losing a parent. However, we also felt compelled to step back and put on our clinician’s hat as their financial adviser.

Client’s Financial Situation

Our clients are exposed to the maximum income tax rate on capital gains (37.1% combined for a California resident) and are subject to the estate tax (40%). Not only are the tax rates extremely similar, but they present a bit of a Sophie’s Choice because of the innate conflict between income taxes and estate taxes.

Our clients own an asset with zero cost basis. For discussion purposes, let’s just call that AT&T stock. They also want to help their own children with a down payment for their houses. Our clients have two choices: gift the AT&T stock while they are still alive or pass it down when they die.

• If they gift the stock while alive, their children will get a carryover of cost basis. The income tax problem wouldn’t go away, it just shifts to the children.
• If our clients pass away with the AT&T stock, the kids will get a step-up in cost basis, allowing the potential income tax to vanish. However, the stock would be part of a taxable estate and subject to the 40% estate tax.

Pick your poison.

Zen and the Art of Motorcycle Maintenance

Robert Pirsig wrote that when confronted with a bull and the necessity to choose between the right horn and the left horn, “throw sand in the bull’s eyes”.

The tax bull can be neutralized through a creative strategy. We recommended that our clients “gift” approximately $750,000 of their AT&T stock, not to their kids but to the mother with Hospice. The parents had to use up part of their lifetime exemption for transfers (currently $11.58 million to each the husband and the wife but designed to sunset at the end of 2025 and resort back to $5 million, indexed for inflation).

The mom can collect dividends from the stock while alive, if needed to supplement healthcare expenses. When the mom passes, she leaves the stock, not to our clients, but to their children with a step-up in cost basis. The children can then sell $750,000 of stock and completely avoid income taxes, saving approximately $278,000 in taxes.

There are a few guidelines to keep in mind:

• Avoid having the assets come back to the gifting parents within one year, or the IRS will disallow the step-up. The easy workaround is to have the gifted assets go directly to the next generation, those children.
• One must have the financial resources for irrevocable gifting.
• Gifting to the parents does use up some of the estate transfer exemption, but there is likely some padding in that allowance right now.
• The elderly parents must not have estates large enough to cause the estate tax to kick in at their death.
• Low cost basis, high-valued assets are ideal.
• Although this situation involved a parent with Hospice, that is not a requirement to make the strategy effective.

Consider talking to your CPA, attorney, or financial adviser soon if you think this might apply because the flexibility around gifting will be reduced when the current exemption reverts back to $5 million.