Taxes, Estate Planning and Financial Theory: New Insights and Perspectives
Robert M. Dammon, Carnegie Mellon University
Chester S. Spatt, Carnegie Mellon University and Securities and Exchange Commission
Harold H. Zhang, University of Texas at Dallas

We examine how financial theory and economic principles offer guidance and predictions about the organization of investments and asset allocation decisions given the structure of taxes in estate planning situations. We provide insight about many of the conventional approaches to estate planning and suggest how these strategies can be enhanced. For example, we show that the advantage of the reset provision by which the investor’s capital gains tax bases are adjusted to the market value at the time of death is greater in the presence of individual rather than joint ownership of assets, provided that at the first death of one of the joint owners the basis is reset to an average of the date of death value and the survivor’s original cost. We analyze asset location and distribution policies in the context of trusts that are outside of the taxable estate of its principal beneficiary as well as direct funds owned by the beneficiary, highlighting the interaction between estate taxation and the reset of the capital gains tax basis at death. We compare the optimal decisions for traditional tax-deferred accounts and after-tax (“Roth”) IRAs. Finally, we also examine the value and importance of borrowing in various contexts in estate planning.

With the growing availability of tax advantaged vehicles on personal account, personal investors face important decisions about how to manage and title their holdings. The results from this research project will help investment managers, sponsors and advisors better understand the implications of estate taxes for portfolio decisions about distributions, borrowing, and titling assets.