retirement

A Widow's Broker Made a Huge Mistake

A step-up in basis can be a massive tax benefit for surviving spouses, but only if it's managed correctly. And sometimes, as in this case, important details can fall through the cracks.

Karen, a recent widow, reached out to me for help with getting financially organized after her husband passed away. Her husband had a broker, but Karen didn't really know him. So she hired me, and together we got to work on her Survivor's Financial Plan, a tool I use to review the financial, retirement, estate, investment and insurances of a new widow.

The Cost Basis Never Stepped Up

As I got to reviewing her investment statements, I immediately noticed something was wrong: The cost basis of the stocks in the joint account were never stepped up to her husband's date of death. The way the tax code works, if a spouse passes, the deceased's share in the cost basis in those shares is stepped up to the value on the date of death. This is important because when you go to sell a stock, the difference between the fair market value and the cost basis (the gain) is the income tax due. This could be extremely costly. If she went to sell the stocks, she would have owed a substantial amount of money in income taxes, since she had a substantial gain due to the low cost basis in the stocks.

Here's how it works. Karen and her husband, John, have a joint investment account holding several individual stocks. They bought the stocks several years ago, and the majority of them have appreciated over time. One stock, a tech firm they bought for $25 per share in 2003, is now worth $180 per share. So, their $5,000 investment ballooned to $36,000. Since they held the stock for more than one year, if they sold, they would owe long-term capital gains tax on $31,000, which is the difference between the $36,000 market value and the $5,000 cost-basis (what they paid). Karen and John are in the 15% capital gains bracket, meaning they owe 15% of the $31,000 gain — or $4,650 — if they sold the stock prior to John's passing.

With John's passing, his share of the stock's cost-basis should have "stepped-up" on the date of his death. This means instead of the cost basis being $5,000, half of the cost-basis should have been increased to $18,000 (half of the $36,000, John's share in the stock on the date of his death). Karen's share of the cost-basis remains $2,500 — half of the original $5,000.

The difference is huge. If Karen went to sell the stock without a step-up in basis, she’d owe $4,650 in taxes. However, with the step-up in basis, she’d owe only half that amount, or $2,325. Repeat this scenario by all the other stocks in their joint account, and you can see the tax-cost would have been significant if she didn't receive a step-up in basis.

We went back to the brokerage firm to correct the problem. But why did this happen?

Having a Joint Account, But Different Last Names Was the Ultimate Culprit

At the majority of investment brokerage firms, the cost basis is automatically stepped-up on the date of death. However, this is not always the case when the deceased and the surviving spouse have different last names, as was the case with my client. She and her husband were married, but she kept her last name. In that case, the brokerage firm didn't automatically step up the basis, but rather needed further instruction from the deceased husband's broker — something the broker must have overlooked.

Luckily, we caught the error in time. The brokerage firm acknowledged the mistake. Since they already had the death certificate on file, which showed the date of death, no new forms were needed. The investment company went back and corrected it, so half of the cost basis in each stock was stepped-up to the date of John's death. Keep in mind it is not always "half" of the value of the position that gets stepped up. If John owned 100% of the stock in an account in his name, the entire basis steps up on his death.

It's often the little things that add up to big things in the world of financial planning and investing. Here, the broker's oversight, if left undetected, could have cost Karen a pretty penny in unnecessary income taxes. The key takeaway here is to always double check that the cost basis is stepped up in the appropriate accounts.

For more financial planning insights for Widows and Widowers, please visit my website at www.survivorplanning.com.

About the Author

Michael Aloi, CFP®

CFP®, Summit Financial, LLC

Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC.  With 17 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.

Investment advisory and financial planning services are offered through Summit Financial, LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients.  Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.

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