Inheriting securities portfolios - Structuring guidelines for reducing tax
When large securities portfolios are inherited the combination of inheritance and income taxes can result in a considerable tax burden. It is possible to protect heirs from such a double burden through clever structuring during one’s lifetime.
Risk of double taxation
In succession planning, the focus of attention is increasingly shifting to the valuation of capital assets for tax purposes. Over the years, high unrealised gains have been built up in many securities portfolios. Upon succeeding into the rights of inheritance, apart from inheritance tax, income tax may thus be incurred in addition. A ruling by the Federal Fiscal Court of 23.2.2022 (case reference: II R 45/19) confirmed that the tax liability in respect of capital gains on shares is also bequeathed.
Inheritance tax is assessed on the basis of the market value of the transferred assets - irrespective of whether or not the appreciation in the values has already been subjected to income tax. If the heirs sell positions in order to generate liquidity for the settlement of the tax liability, then, if the appreciation in the values has not already been taxed by the testator, the heirs would incur an income tax charge in addition. This effectively leads to double taxation.
Problems associated with valuations for tax purposes
Upon succeeding into the rights of inheritance, in the case of exchange-listed securities, the market price quoted on the date of death is applicable. With regard to inheritance tax, exempt amounts are granted on the basis of the degree of kinship. Spouses and children benefit from high exempt amounts (e.g., €500k and €400k respectively), for more distant relatives and third parties the exempt amounts are considerably lower. The assessment of the value of the assets for inheritance tax purposes is carried out irrespective of a potential income tax charge on future gains - this is a systemic problem that is not sufficiently taken into account in many estate plans.
An approach to avoid double taxation
From a tax perspective, an effective approach to avoid a double burden lies in deliberately realising capital gains still during one’s lifetime. This admittedly triggers an income tax liability, however, the withholding tax would then arise at a point in time when there is liquidity available and the impact of the tax charge can be planned. As a result, the value of the estate would be reduced by the amount of income tax on the appreciation in the values - and the assessment base for inheritance tax would thus also be reduced.
Practical case study – An 80-year-old widow would like to plan her estate. The entire value of her estate is made up of shares in the amount of €1m. These shares were purchased after 1.1.2009 for €500k. If one child is the sole heir, then without taking into account the exempt amounts, the inheritance tax would be €190k. Sooner or later, the appreciation in values has to be taxed and they would trigger withholding tax in the amount of €125k on a capital gain of €500k. In the example here, the sale of the shares during the woman’s lifetime - if withholding tax at a constant level is assumed - would cause the value of the estate to fall to €875k whereby the inheritance tax would be reduced by €24k.
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