To Gift, or not to Gift: Income Taxes vs. Estate Taxes

June 13, 2024 | Patricia C. Marcin | Trusts & Estates | Tax

Giving assets away during lifetime to reduce estate taxes due upon your death is not the “no-brainer” it used to be. Sometimes, holding onto assets until your death lowers total taxes.

Income tax, gift tax and estate tax benefits can differ dramatically, depending on the income tax basis of the assets to be gifted or bequeathed. Looking closely at the tax basis of your assets may  help you determine whether to gift them or bequeath them.

The federal government and New York State impose a capital gains tax on the appreciation of an asset when sold (the “capital gain”). When you gift an asset, the recipient takes the asset with your income tax basis, which, generally, is the amount you paid for the asset. In contrast, when you bequeath an asset upon your death, the income tax basis is “stepped up” to the value of the asset on your date of death. Your beneficiary takes the asset with the new stepped-up basis, and the capital gain upon a subsequent sale is measured from the value at your date of death.

The combined federal and New York capital gains tax rate can total 31.5%. In contrast, the top federal estate and gift tax rate is 40%, and the New York estate tax rate tops out at 16%. New York  has no gift tax (although gifts made within three years of death are included in determining a decedent’s NYS estate tax). The NYS estate tax exemption is currently $6.94 million; the federal gift and estate tax exemption is $13.61 million.

The following example illustrates the taxes that come into play when gifting versus bequeathing an asset. John has two sons, Sam and Matt. John owns $10 million in stock, and his basis in the shares is $1 million. John has no other assets.

Scenario 1 – Gift the Stock
John gifts the $10 million in stock to Sam and Matt in January 2021. There is no federal gift tax, as the value of the gift ($10 million) is under John’s federal gift tax exemption. Sam and Matt sell the stock in April 2021 for $12 million, recognizing a capital gain of $11 million.

Tax Consequences
Federal & NYS Gift Tax $0
NYS Estate Tax $0
Capital Gains Tax $3,465,000
Total Tax $3,465,000

Scenario 2 – Bequeath the Stock
John retains the stock until he dies in January 2024. John bequeaths the stock to Sam and Matt under John’s will. Sam and Matt sell the stock in August 2024 for $12 million.

Tax Consequences
Federal Estate Tax $0 (the estate is below the federal tax-exempt limit)
NYS Estate Tax $1,386,800 (tax on the $12 million estate)
Capital Gains Tax $0 (the stock’s stepped-up value is $12 million)
Total Tax $1,386,800

The tax savings achieved by holding stock until death is $2,078,200.

Therefore, when deciding whether to gift or bequeath assets, one must balance the combined federal and NYS estate taxes on assets passing at death against capital gains taxes on the sale of the gifted assets.

This article appeared in the June 2024 issue of Stroll Lloyd Harbor.

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