20.4 Estate Planning for Individuals: Gift vs. Inheritance, Trusts, Family Partnerships, Charitable Giving, Life Insurance & Long-Term Care

Why This Topic Matters

The Advising domain lists "Estate planning (e.g., gift versus inheritance, trusts, family partnerships, charitable giving, long-term care, life insurance)." These questions ask the enrolled agent to recommend the approach that minimizes the combined income, gift, and estate taxes for a family. With a 2025 basic exclusion of $13,990,000 per person (rising to $15,000,000 for 2026 under OBBBA), most families owe no transfer tax, so income tax basis often drives the answer.

Gift vs. Inheritance: The Basis Comparison

Planning rules of thumb:

1. Keep highly appreciated assets until death so heirs receive a stepped-up basis.
2. Give cash or high-basis assets during life, especially assets expected to appreciate (future growth is removed from the estate).
3. Sell loss assets rather than giving or holding them: the donor can use the loss, while a donee is limited to FMV basis and heirs lose it entirely.
4. Use the annual exclusion every year and the unlimited exclusion for tuition and medical expenses paid directly to the provider.
5. Watch the kiddie tax when giving income-producing assets to children and full-time students under 24.

Example: Rose, age 85, owns stock worth $500,000 with a $50,000 basis and a CD worth $500,000. If she gives her son the stock now, he takes a $50,000 basis and would owe capital gains tax on $450,000 if he sold it. If she gives him the CD and leaves him the stock at death, the stock's basis steps up to its date-of-death value and the built-in gain is never taxed.

Trusts in Individual Planning

Family Partnerships (IRC §704(e) and Publication 541)

A family partnership (often a family limited partnership) is used to shift income and to transfer ownership at discounted values. Under the family partnership rules (IRC §704(e), Treas. Reg. §1.704-1(e), and Publication 541), a family member who receives a partnership interest by gift is recognized as a partner only if:

• Capital is a material income-producing factor in the business (a partnership that earns income mainly from the owners' personal services, such as a consulting practice, cannot shift income by giving interests to children); and
• The donee actually owns the interest (real dominion and control, not a paper transfer).

The donor partner must be allocated reasonable compensation for services first, and the donee's share of the remaining income cannot be proportionately greater than the share attributable to the donee's capital. An interest purchased from a family member is treated as if it were created by gift for these rules. For transfer tax, discounts for lack of control and marketability are scrutinized, and if the donor keeps control or enjoyment of the property, IRC §2036 can pull it back into the estate.

Charitable Giving Strategies

• Donate appreciated long-term stock instead of cash: the donor deducts fair market value (30% of AGI limit for public charities) and never pays tax on the gain.
• Qualified charitable distributions (QCDs) from an IRA after age 70½ (up to $108,000 for 2025) satisfy RMDs and never enter AGI.
• Bunching gifts into one year, often through a donor-advised fund, lets a taxpayer itemize in alternate years (a donor-advised fund cannot receive a QCD).
• Charitable remainder and lead trusts combine an income stream or estate reduction with a charitable deduction.
• Bequests to charity are fully deductible for estate tax, and naming a charity as beneficiary of a traditional IRA avoids income tax on the IRD entirely.

Life Insurance

• Income tax: Death benefits paid because of the insured's death are excluded from income (IRC §101(a)); interest paid on installment settlements is taxable. The transfer-for-value rule can make proceeds taxable if the policy was sold for value (exceptions include transfers to the insured, a partner of the insured, or a partnership or corporation in which the insured is a partner or shareholder).
• Estate tax: Proceeds are included in the insured's gross estate if payable to the estate or if the insured held incidents of ownership, and under IRC §2035 if the insured transferred the policy within 3 years of death. An ILIT that buys the policy from the start avoids the 3-year rule.
• Cash value policies: A loan from a policy that is not a modified endowment contract (MEC) is not taxable while the policy stays in force. A surrender, or a lapse with a loan outstanding, is taxable to the extent the amount received (including any loan balance cancelled) exceeds the premiums paid (investment in the contract). MEC loans and withdrawals are taxed gain-first and can carry the 10% additional tax before age 59½.

Long-Term Care

• Premiums: Qualified long-term care insurance premiums are medical expenses subject to age-based caps (for 2025: $480 at 40 or under up to $6,020 over 70), deductible on Schedule A above the 7.5% floor, or as self-employed health insurance for self-employed individuals.
• Benefits: Reimbursements of actual care costs are tax-free; per diem benefits are excluded up to $420 per day for 2025 (or actual costs if greater).
• Hybrid policies: Charges against a life insurance or annuity contract's cash value for qualified long-term care coverage are not taxable distributions (IRC §72(e)(11)), and Section 1035 exchanges into a long-term care contract are tax-free.
• Accelerated death benefits paid to a terminally or chronically ill insured are generally excluded (IRC §101(g)).