already been used and use a 50% rate. Gift Tax Estate Tax Parent gives child Parent dies and leaves $1,000,000 $1,000,000 $1,500,000 to child $1,500,000 Parent owes 50% gift tax $500,000 Estate owes 50% estate tax $750,000 Net to child $1,000,000 Net to child $750,000 Total cost to parent $1,500,000 Total cost to parent's estate $1,500,000 Child's net/total cost 66% Child's net/total cost 50% Effective tax rate 33% Effective tax rate 50% to the full 55 percent rate in the following year. This level of uncertainty plays havoc with estate planning. Tax considerations impact analysis in several ways. 1.    Not all returns are equal. Municipal bond interest is generally free of federal tax. Income and dividends are taxed immediately at ordinary tax rates while appreciation is taxed if and when realized at either short- or long-term tax rates. 2.    Disposal plans affect taxation. Capital gains taxes on unrealized gains can be avoided if appreciated assets are given to charity or held until death.2 3.    Reallocation is costly. Equities tend to appreciate, so the reallocation of an individual's assets may require the payment of capital gains taxes. This is one of the most significant differences relative to investment planning for tax-exempt investors. This issue is particularly relevant for individuals who create their wealth through the ownership of a business. A public offering or stock swap can create the situation where much of the individual's wealth is in a single low-cost-basis stock. Sale of the position to diversify and reduce risk will require a large capital gains tax payment. There are estate planning and hedging strategies that can reduce the tax burden required to diversify from a concentrated and appreciated position. 4.    Estate planning structures complicate the calculation of expected after-tax return. Individuals often have various entities within which they can hold assets. Examples include grantor trusts, charitable trusts, family limited partnerships, retirement accounts, and foundations. Each has its own income, gift, and estate tax characteristics. For example, an IRA defers taxation on all returns, converts all returns to ordinary income, and is not eligible for the step-up basis at death. Thus, the expected after-tax return of an asset, factoring in both income and transfer taxes, can vary greatly depending on the type of entity in which it is held. 2The tax-free step-up in basis eliminates tax liability on unrealized gains at death. This feature of the tax code is related to the estate tax and might be eliminated if the estate tax is eliminated.