How to approach estate planning for non-taxable clients

Vanilla recently hosted Jeff Levine, the lead financial planning nerd for, home of the popular Nerd’s Eye View blog, for a webinar covering key considerations when planning for non-taxable estates.

While it’s impossible to pack all the great info Jeff covered in a short blog post (including a rather spectacular metaphor involving the Red Hot Chili Peppers), we’ll give you a few highlights.

What are the boundaries of advice financial advisors should give in estate planning?

Financial advisors often grapple with the question of where the line lies between estate planning discussions and offering unqualified legal advice. Jeff weighed in that most general estate planning guidance given to clients is completely within the scope of what a financial advisor can do. Advanced financial planning degrees or designations such as CFP, CPWA, and CM all incorporate tax and legal planning into their curriculum. This training is not designed to lead advisors into potential trouble but is instead a recognition of the multifaceted role advisors play in the lives of their clients.

The critical distinction lies in the nature of the advice given. If an advisor begins suggesting specific legal alterations to a client’s will, such as changing particular provisions or words, they’re likely crossing a line. However, educating a client about the potential outcomes of their current estate planning strategies or suggesting broad improvements falls within the role of a financial advisor.

Levine likens this to the concept of ‘Big T, Big A’ versus ‘little T, little A’ advice in the tax realm, which can be applied to estate planning too. Financial advisors cannot draft legal documents – that’s the realm of qualified legal professionals. Yet, nothing prevents an informed advisor from identifying potential improvements in a client’s estate plan, such as reducing tax liability or transferring assets more efficiently.

The key lies in collaboration and communication. Advisors can and should involve the client’s estate planner in these discussions to ensure everyone is aligned and to consider potential changes. This approach maximizes the value advisors can provide while maintaining a respectful professional boundary.

In summary, the line between estate planning discussions and unqualified legal advice is determined by the nature of advice offered. Advisors can confidently offer high-level guidance and educational insights within their role without crossing into unqualified legal advice. Collaboration with other professionals, such as estate planners, ensures a comprehensive approach that best benefits the client.

The step-up-in basis

Advisors should first and always make sure clients have accurate and up-to-date estate planning documents that facilitate a smooth transition of assets to their heirs. Beyond ensuring a proper plan is in place, the other area where advisors can help out is helping clients think about asset locations, where they are titled, and the tax implications. 

But since federal estate tax doesn’t concern most clients, advisors can shift their focus to income tax planning for death, which Levine suggested comprises three key elements:

  1. Filing the final tax return: Voluntary elections clients can make on their final tax return often go unnoticed but can significantly benefit beneficiaries. An example Levine mentioned pertained to EE bonds. A decedent can choose to report all accrued income on their final tax return, which could potentially reduce the tax burden on the beneficiary.
  2. Unwinding tax-favored retirement accounts: The 10-year rule, the death of the stretch IRA, and the implications of these for retirement accounts like IRA, 401k, and 403b are important considerations. For instance, the IRS recently clarified that no required minimum distributions (RMDs) during the 10-year rule need to be taken for this year.
  3. Maximizing the step-up in basis: This approach can greatly benefit individuals upon the death of a client and is an area where advisors can have a significant impact. In simple terms, assets that are not income in respect of a decedent (IRD) receive a step-up in basis, meaning they are treated as though the beneficiary purchased that asset on the day the client died. This provision essentially wipes out the unrealized capital gains tax. However, the downside is that if the asset’s value has decreased since it was bought, the unrealized loss is also wiped out.

The challenge, therefore, is to maximize the step-up in basis for assets and minimize the step-down. The key concept is that an asset must be included in the decedent’s estate to receive a step-up in basis. Gifting an asset before death removes it from the estate and consequently eliminates the step-up benefit for the heirs.

Interestingly, while most discussions refer to this provision as “step-up in basis,” Levine pointed out that the more accurate term is “step to the fair market value on the date of death basis.”

Joint tax returns and capital losses

Joint tax returns are not simply a matter of collective income, deductions, or credits; instead, it is a compilation of individual factors – his income, her income, and so forth. This principle plays a crucial role in understanding capital losses, particularly their disposition upon death.

Capital losses and other carry-forwards – such as credits – die along with the person who incurs them. This is a common misinterpretation among CPAs, who often erroneously maintain the full capital loss on a return. This is contrary to a 1974 revenue ruling, which mandates the elimination of the decedent’s share of those losses.

To minimize such losses, two approaches exist based on the status of the loss: realized (already sold the asset) or unrealized (asset down in value, but not sold). For realized losses, the strategy is to sell an asset with a gain to offset the loss – a simple ‘use it or lose it’ approach. Regardless of the asset’s perceived value, it is worth selling and buying back to effectively step up your basis by the amount of capital loss you had.

In cases of unrealized capital losses, the strategy is to ‘give it away’ before death. Transferring such assets to a non-spouse triggers ‘double basis rules,’ whereas transferring to a spouse allows the basis to carry forward without alteration. A strategic allocation of assets between spouses can optimize both the continuation of unrealized losses and the step-up in basis for assets that have appreciated, potentially exempting the surviving spouse from capital gains tax for life.

Joint vs separate property states

In separate property states, the tax code regards an account structured as either a tenancy by entirety or joint tenancy with rights of survivorship as a ‘qualified joint interest’. In these situations, the presumption is that each spouse owns 50% of the account. Levine emphasized that this is very different from non-spousal joint ownership situations, where there is no such presumption.

In a separate property state, if either spouse passes away, there’s a half step-up in basis because half of the account that the deceased spouse owned was eligible. However, this also means that the other half of the account doesn’t get a step-up in basis.

Contrastingly, in community property states, which include the most populous states like California and Texas, each spouse is considered to own 100% of the property. This paradoxical concept results in a full step-up in basis upon the death of either spouse, regardless of how the property is titled.

Jeff used a practical example to demonstrate these concepts. If a married couple each had separate accounts titled under their names and a joint account, all funded with $50,000 and grown to $200,000, the gain would be $150,000.

If the couple lived in a separate property state and the wife passed away, the husband’s separate property would not change. The joint account would follow qualified joint property rules, treated as though each owned 50%, leading to a $100,000 step-up. The account titled in the wife’s name would receive a full step-up in basis.

However, in a community property state, regardless of how each account was titled, they would all be considered community property since they were funded during the marriage with marital assets. This means each account would get a full step-up in basis upon the wife’s death.

So, while tax planning in separate property states isn’t necessarily unfavorable, the rules in community property states could provide more significant benefits regarding step-up in basis. This distinction becomes crucial for advisors to understand, especially given today’s geographically dispersed world where clients may move and change their domiciles.

Additional webinars and courses to come

Jeff had far too many nuggets to summarize in one (relatively) short blog post, but we hope you’ll tune in to Vanilla and partner webinars in the future to learn more about estate and financial planning as well as the technologies that can help empower advisors to bring even more value to their clients.


The information provided here does not, and is not intended to, constitute legal advice or tax advice; it is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with your financial advisor or estate attorney who can advise as to whether the information contained herein is applicable or appropriate to your particular situation.

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