We all know the important date of April 15, Tax Day.
Even Albert Einstein once said, “The hardest thing in the world to understand is the income tax.”
I feel better knowing that even Mr. Einstein struggled to understand income tax. However, this column is not about how to file an income tax return, but rather is about income tax planning.
When talking about taxes, it is important to note that there are two major categories of taxes for estate planning purposes, estate tax and income tax. While not that long ago the Federal and State estate tax exemptions were much lower than they are today, the estate tax exemptions have grown significantly. Currently a single individual can shelter $4 million in Illinois estate tax and $13.61 million in Federal estate tax (This is double if you are married.). This makes planning for the second category, income taxation, increasingly the focus for many of us.
Tax basis is the cost or value of an asset—used to determine equity or ownership for the purpose of tax assessment, exchange, or sale. This foundational definition is very important to income tax planning. When you transfer to a beneficiary or sell a security, the basis is the starting point from which an income tax is assessed. When an individual dies, most assets includable in their gross estate receive something called a “basis adjustment.” The basis, or starting point for tax assessment, is adjusted to the value of the asset on the owner’s date of death. Traditionally, this adjusts the basis upwards, which raises the starting point of the tax assessment, resulting in a lower income tax.
Through the use of various planning tactics, I assist clients regularly in income tax planning so that their beneficiaries are in the best income tax situation they can be. Planners must understand and recognize which assets an individual owns which may have a very low basis and work to ensure adjustment occurs on those assets, if possible, before gifting them, selling them, or transferring them at death. In the right situation, we can even ensure that a basis adjustment occurs at the first spouse’s passing AND at the second spouse’s passing which can save the family significant income tax liability.
