Tax planning is the art of considering all of the various taxes (and tax rates) which might apply to a taxpayer, or a transaction, and choosing which tax to pay and when to pay it. Good tax planning also includes planning the best way to pay the tax when it becomes due. This requires looking at the client’s assets (i.e., is there enough cash, or would a family business or real property have to be sold?), and cash flow (will the client have enough income after the transaction to live on? Is the client asset rich and cash poor?). Sometimes income or asset replacement (possibly with life insurance, or a commercial or private annuity) is an appropriate way of meeting lifetime and post death tax obligations.
Our firm reviews each client’s unique situation in light of the big five taxes: estate, gift, generation-skipping, property and income taxes. Our advice helps clients to legally and safely minimize and defer these taxes, giving them more certainty and peace of mind.
An important piece of what we do is planning for the federal estate tax. This tax is imposed at 40% on assets transferred at death. The tax applies after a certain threshold (the “basic exclusion amount”, or “Exclusion”) has been reached. For 2026, the Exclusion is $12,060,000 per taxpayer, meaning a couple can shield $24,120,000 from the estate tax. This Exclusion is expected to continue to increase with inflation through 2025, then will be cut in half. This “estate tax cliff” will have a significant impact on larger estates, who need to “use or lose” the excess exclusion before 2026.
The good news is that the IRS has determined that if you use the excess exclusion before 2026 you will never have to pay an estate tax on the excess gifted. In addition, married persons who lose a spouse have the option of claiming any unused Exclusion of the deceased spouse to use later, even after their own exclusion has been cut in half. To get these benefits, gifts must be properly structured (and larger than the future exclusion amount), and appropriate tax elections must be made.
Our firm stays current not only on the law, but also on what changes have been proposed in Congress which could affect the client’s planning, allowing our clients to prepare for the more likely tax changes in the future. We also prepare federal estate tax returns to claim the benefit of the unused Exclusion for the surviving spouse, to document the basis step-up for assets, and in appropriate cases, to verify and pay the tax due.
Another important part of tax planning deals with the federal gift tax. Like the estate tax, it is a 40% tax imposed on transfers, but it only applies to lifetime gifts. The same basic exclusion amount shields a portion of the gift from immediate tax (up to $12,060,00 in 2022). In addition, the annual exclusion amount ($16,000 per donee in 2022) can shield a portion of the gift from this tax. Proper use of these exclusions can make lifetime gifts quite valuable.
Lifetime gifts offer unique benefits. First, such gifts are made “tax exclusive”, meaning the tax is imposed only in the value of the gift, not on the donor’s entire estate, allowing a larger gift to be made for less tax cost. Second, lifetime gifts allow assets to grow outside the donor’s estate, so that the increased value is not taxed at the donor’s death. Properly structured gifts can also defer the estate tax for several generations of your heirs even while providing those heirs with immediate income and principal.
Lifetime gifts do come at a cost, and this cost needs to be considered carefully before the gift is made. The donee generally receives a “carry-over” income tax basis in the assets received – meaning if your basis is low, the donee also has a low tax basis. In contrast, most assets gifted at death receive a new fair market value income tax basis (often called a “basis step-up”). It is important to consider the potential loss of this basis step-up before making a gift because it can be a valuable benefit.
Lifetime gifts must be reported to the IRS by April 15th of the year following the gift. Gift values must be properly substantiated with appraisals and valuations when needed (which can be expensive). Failure to properly substantiate and report gifts can lead to increased costs and possibly to the loss of discounts and other benefits associated with the gifts.
We work with clients to identify appropriate assets to gift and options for gifting that can use less of the donor’s lifetime Exclusion. We also work with donors to properly document gift values and to timely report them to the IRS.
The federal generation-skipping transfer tax is another 40% tax imposed on gifts in life or at death, and is applied in addition to these other taxes. It is possible for a single $100,000 gift to be subject to $64,000 in taxes, leaving only $36,000 for the donee. Proper planning is required to avoid this very bad tax result.
The generation-skipping tax (GST) applies to gifts made to “skip persons”, such as grandchildren or others in a generation below that of your children. The GST exclusion is applied automatically to lifetime gifts unless the taxpayer files a timely gift tax return to elect out of that result. Proper tax planning includes deciding when (and when not) to use the GST Exclusion, and ways to avoid triggering this tax the first place.
Our firm’s careful planning includes the use of trusts and other entities to minimize the negative effects of this tax on you and your family.
California Property Taxes
For many Californians, your home is your most valuable asset. Before Prop 19 passed, parents could use the Parent-Child Exclusion to gift a home of any value, plus up to $1 million of assessed value in other real property, to their children (or possibly grandchildren) without a property tax reassessment. Prop 19 severely limited the Parent-Child Exclusion – it now only applies to the transfer of the parent’s primary residence and it only applies as long as the child also continues to use the home as his or her primary residence. In addition, only up to $1 million of increased value can be shielded; the excess is reassessed.
Prop 19 did make transferring a home’s low tax basis to a new home less difficult, but to claim this benefit you must properly document and report the purchase and the sale and a partial reassessment can still occur if the purchase price of the new home is greater than $1 million more than your property tax basis in the prior home.
A totally different set of rules applies to real property owned in an entity. These rules require tracking how the property was acquired (was it contributed to the entity or purchased by it?), and a reassessment may be triggered by a change in the control of the entity or by the transfer of more than 50% of the entity itself. Transfers of real property between entities, even entities owned by the same people, can also trigger a reassessment. Finally, putting your personal residence into an entity can be disastrous for taxpayers, costing them both the Parent-Child Exclusion and other benefits.
If you are considering transferring an interest in your home or other real property or changing the ownership of an entity that holds real property, we can help you to navigate these rules and make the best choices to avoid triggering an unnecessary property reassessment.
Proper tax reporting by businesses is important. The State of California taxes the income generated by any business that is run from inside California, even when the assets are located outside of the state. Failure to register the out of state business in California can result in large fines and back taxes. Using an out of state management entity (for example, in Nevada or Arizona) does not exempt the entity from California income taxes if the CEO resides in California and oversees business operations from an office in his home.
In addition, different business forms are taxed differently in California. Partnerships, limited liability companies, and closely held “S” corporations are “pass through” entities whose income is taxed to the entity owners. These entities may be entitled to special tax benefits under IRC Section 199A, and may be able to deduct the full amount of property taxes paid while an individual can deduct no more than $10,000. While not subject to federal tax on their income, these entities are subject to the California annual $800 minimum franchise tax (with additional amounts based on their income), and S corporations must pay the greater of $800 or 1.5% of their income.
We work with our client’s CPA, financial advisor and others to ensure the client understands the complexities of federal and California tax rules, and to maximize the use of available deductions.
We advise taxpayers on their options to minimize federal and state income taxes on future “realization” events, such as the sale of a business, and to document and report taxes when due. California’s rules for taxing irrevocable trusts are extremely complicated; in addition to taxing state trusts, it also taxes out of state trusts with California beneficiaries or which eventually distribute principal to a California beneficiary. This “throw-back” tax, if triggered, can cause substantial taxes to be due unexpectedly. The federal government also imposes its own form of a throw-back tax to reach the income of foreign irrevocable trusts which distribute principal to US citizens.
Income tax rules are subject to constant changes. For example, Congress recently considered eliminating the basis step-up at death provided by IRC Section 1014. This income tax change could have a substantial effect on both gift and estate planning by eliminating one of the barriers to making lifetime gifts – the loss of the basis step-up at death.
We work closely with our client’s CPA and financial advisor to address questions of what income is subject to federal and California (or other state) income taxes, when income must be recognized and when it can be deferred, and the proper taxation of irrevocable trusts. We also help clients to position themselves, and their assets, to avoid unnecessarily triggering throw-back and other taxes.