Deathbed Planning Has its Drawbacks
Contemplating the end of your life isn’t a fun experience. Making an estate plan and keeping it up to date may not be your favorite activities, but they can save your loved ones a lot of pain and difficulty after your death. Having a plan can also put your mind at ease and give you confidence that things will be handled the way you want them to be.
However, having a plan that’s out of date could push you to make deathbed gifts as a way to account for current circumstances. There’s an understandable appeal to giving gifts to your loved ones while you’re still around to see their reaction. That said, there are several problems with deathbed giving, not least of which is that most people don’t actually know when the end will come. Mistakes tied to deathbed giving can harm the person making the gift, as well as the loved ones they’re trying to help.
Capital Gains and the Basis Adjustment
Most gifts are given to show love and bring happiness to the recipient. Unfortunately, deathbed gifts can be far less beneficial than leaving that property to them as part of an estate plan.
Under federal tax law, a capital gain occurs if property is sold or exchanged for more than its original price. The original price is called its basis. When you give someone a gift while you’re still alive, the person getting the gift takes on the same basis you had. The legal term for this is carryover basis.
If you receive property as part of an inheritance, however, the basis of the property will likely be the fair-market value at the time of death: This is called a basis adjustment or step-up in cost basis. This makes a difference in cases where the value of the property being transferred is higher than it was when first acquired.
Example:
You decide to give a gift to your daughter on your deathbed. You give her an antique desk you purchased in 1979 for $20,000. The piece is currently valued at $150,000, an increase of $130,000. Your daughter will have the same cost basis for that desk that you do, $20,000. That’s the carryover basis for the desk.
If your daughter needs to sell the item for its current value of $150,000, the $130,000 profit will be taxable as capital gains to her. Conversely, if you left the desk to your daughter as part of your estate plan, her basis will be “stepped up” to $150,000, its fair market value on the date of your death. If she immediately sells it, she will have no capital gains, and thus, will benefit from significant tax savings.
Gifts Might Still Be Subject to Estate Taxes
One reason people with larger estates choose to make gifts is to reduce estate tax liability. Gifts made on the deathbed, however, might still be a part of your estate if they are not considered “completed” gifts under federal tax law.1
A recent case, Estate of DeMuth v. Commissioner,2 dealt with a situation in which a father’s health began to worsen. His son, as his agent under a power of attorney, wrote eleven checks on September 6, 2015, from his father’s investment account totaling $464,000 to different recipients in an effort to take advantage of the annual gift exemption ($14,000 in 2015). The father died on September 11, 2015. Some of the recipients had deposited their checks before the father’s death, but some had not.
Treasury Regulation § 20.2031-5 provides that the “amount of cash belonging to the decedent at the date of his death, whether in his possession or in the possession of another, or deposited with a bank, is included in the decedent’s gross estate.” The Tax Court found that under Pennsylvania law, which was applicable to determine when the gift of a check was a completed gift, delivery of a check does not complete the gift.3
Instead, only checks actually deposited by the recipients before the father’s death and credited to their bank accounts were considered completed gifts. Those that were not deposited or paid by the investment company should be included in the father’s estate because he (or his son as his agent) could have stopped payment on those undeposited checks until his death.4 Estate of DeMuth highlights the importance of planning ahead rather than waiting until the last moments or days of life to make a gift, particularly if the goal is to reduce your estate tax liability.
Although gifts made within three years of your death are generally includible in your estate,5 there is an exception if a gift tax return was not required to be filed because the value of the gift was less than the annual exclusion amount. Transfers relating to life insurance policies, however, are an exception to this exception.6 If you’re considering transferring life insurance policies before your death, it’s important to talk to an experienced estate planning attorney about the tax consequences of the transfer.
A California Estate Planning Attorney Can Help
Making estate planning and gift-giving decisions from one’s deathbed is not ideal. An estate planning lawyer can help you put a plan together that will accomplish your goals and protect you and your loved ones.
At the Law Office of Janet L. Brewer, we offer experienced guidance to help people create or update their estate plans. We can help you build a solution that limits tax liability and reduces conflict. Call our Los Altos offices at 650-325-8276 to schedule a consultation.
Notes
1 See I.R.C. § 2035(c)(3); Treas. Reg. § 25.2511-2(b) (“[I]f upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case.”).
2 124 T.C.M. (CCH) 22 (2022) (appeal filed).
3 In re Mellier’s Estate, 182 A. 388, 389 (Pa. 1936).
4 Several of the checks that the Internal Revenue Service (IRS) had mistakenly conceded were not included in the father’s gross estate were excluded from it. But for the IRS’s mistake, the amounts of those checks also would have been included.
5 I.R.C. § 2035(a).
6 I.R.C. § 2035(c)(3).
