If you own a lot of stock, you may be concerned about whether your heirs will have to pay estate tax on the stocks after you die. Estate tax only applies to very large estates, worth millions of dollars, so it's worth remembering that many estates of fairly well-off people won't be affected at all.
TL;DR (Too Long; Didn't Read)
Estate tax generally doesn't discriminate between different types of assets, so there's generally no estate tax advantage to converting stocks to cash. Depending on whether your stocks have gained or lost money, there may be capital gains and income tax advantages to cashing them in before you die or leaving them for your heirs.
Considering Estate Taxes After A Death (and Before)
When someone dies and leaves an estate worth more than the federal estate tax limit, the estate is required to file IRS Form 706, an estate tax return. The federal limit is $11,180,000 for 2018 and $5,490,000 for 2017. If you have an estate of that size and are concerned about minimizing tax, it can be a good idea to consult with advisors such as financial planners, tax accountants and attorneys.
Generally, estate tax applies no matter what form your assets are in, whether they are stocks, bonds, bank certificates of deposit or cash stuffed under a mattress. There's typically no estate tax advantage to converting your assets from one form to another.
If you are concerned about estate tax, you can consider making gifts to some of your potential heirs while you are still alive. Generally, gifts under a certain threshold per person per year are exempt from gift tax, though once you go above that limit any additional gifts to that person will begin to diminish your estate tax limit after you die.
You can generally give shares as well as cash to a relative or friend by working with your broker, so you don't need to liquidate your holdings to transfer them to a loved one.
Considering Capital Gains Taxes
You may wish to consider the capital gains impact of holding on to stocks until you die versus selling them while you are still alive.
If you sell a stock that has gone up in value since you've owned it, you will owe capital gains tax on the difference between the purchase price including commissions, known as the cost basis, and the amount you get when you sell it. If you've held the stock for a year or more, you'll pay the long-term capital gains rate. Otherwise, you'll pay your generally higher ordinary income rate. If you sell a stock that's lost value, you will see a capital loss, which you can use to offset other capital gains and, to a limited extent, ordinary income.
If someone inherits stock, the basis effectively resets on the date of the deceased person's death or a date six months after, depending on choices made by the estate administrator. Either way, the new cost basis of inherited stock means that those capital gains will effectively go untaxed when the heir ultimately sells, though any capital losses will also lose their useful tax status.
Essentially, it may be worth selling stock that's lost value while you're alive to claim the capital loss and it may be worth holding on to stock that's grown in value to effectively erase capital gains tax when it's passed to your heirs, though that decision will also depend on whether you need cash for your own use and whether you think the stock will go up or down in value while you're still alive.
2018 Tax Law Changes and Inherited Stocks
The estate tax limit is doubling in 2018 to $11,180,000 from $5,490,000, which will mean fewer estates will have to worry about estate taxes. Additionally, the annual per-person untaxed gift limit is rising from $14,000 to $15,000, which will mean that you can transfer slightly more to friends and relatives every year you're still alive without worrying about taxes.
Long-term capital gains tax rate brackets are shifting only slightly, and capital gains rates are set at 0 percent, 15 percent and 20 percent, depending on your total income.
2017 Tax Law Situations
Under 2017 tax law, estates under $5,490,000 and annual total gifts to someone of under $14,000 are exempt from gift tax.
Long-term capital gains tax rates are set at 0 percent, 15 percent or 20 percent, depending on your income tax bracket.
- Center on Budget and Policy Priorities: Ten Facts You Should Know About the Federal Estate Tax
- IRS: What's New - Estate and Gift Tax
- The Motley Fool: The Estate Tax
- Investopedia: Can I Give Stock as a Gift?
- IRS: Publication 550 (2017), Investment Income and Expenses
- Forbes: IRS Announces 2018 Estate And Gift Tax Limits: $11.2 Million
- The Motley Fool: Your Guide to Capital Gains Taxes in 2018
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.