Capital Gains Tax is the tax charged on any income from the sale of an asset after August 1985. If your capital gains are more than your capital loss then you will owe tax for the difference and must be shown in the tax return for the year. When planning an estate one of the key considerations is how to minimize the effects of capital gains taxes. There are three ways to minimize the effects of capital gains tax when planning an estate. Remember to consult with your financial advisor before making any move.
As of 2009 you are allowed to give up to $12,000 per year per person to as many people as you want. If a married couple chooses to split their gifts they can give up to $24,000 per year per person because they are doing so as two individual people. This amount is subject to change over time. The IRS also allows an additional gift of one million dollars in a persons lifetime without paying the gift tax. You can also contribute to family medical bills or tuition to reduce the estate without paying gift tax; the drawback is that the money must go directly to the provider of the medical care or the school providing education.
Some people plan to leave assets to their children, who then pay estate taxes upon those assets. If the assets are then passed down to another generation the assets are taxed again. Because of this, many estates are set up to send assets directly to the grandchildren. The IRS tries to limit this ability with the generation skipping tax (GST). This tax kicks in when the beneficiary is two or more generations removed from the estate holder. The way around this is to use one of two methods. You can use the annual gift method of giving $12,000 per person per year as mentioned above; you can move a substantial amount of the estate to family members this way. The other method is to set up a trust for the grandchildren while you are alive. Use the GST exemption now (the 3.5 million in a lifetime) and the appreciated value of the assets will be outside of the capital gains tax and the estate. You must show this trust and GST exemption on your gift tax return for the year you use the exemption.
The Bypass Trust
This is a legitimate method to shelter money from the taxable estates of both husband and wife. The amount you can use is subject to the current federal estate tax exemption. As of 2009 this is set as $3.5 million. What you put into the trust is not included in either spouse’s estate for capital gains tax. Use assets which will appreciate in value for this type of trust such as real property or collectibles. Don’t use retirement funds such as IRA’s or 401(k) accounts. These accounts must be liquidated according to the rules of minimum distribution over your expected life span. The assets used to fund the trust will move up to fair market value on the date the account holder passes away. This raise will either reduce or eliminate the capital gains tax at the time the assets are sold off.