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If you filed your taxes last month, you know the pain of capital gains is real and often a surprise come April.
I recently wrote two surprisingly long and complicated columns on strategies to minimize the tax hit that comes when you press the “sell” button on an appreciated stock.
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This is a similar idea, but the gift is down, i.e., to your kids.
We work with folks in or near retirement, which is typically the sweet spot for such a strategy. We also work with people who tend to be comfortable financially, when they can say with a level of confidence that they’ll be OK. That allows the flexibility to think about how they can help their kids.
Make sure you’re financially secure first
When you give stock to a child, it’s considered a completed gift, which means you’re not getting that money back.
You should double-check your financial plan to make sure you’re going to be financially secure before considering this.
If you don’t have a plan or want to double-check the one you have, you can access a free version of the software we use.
The idea here is simple. Want to give your kids money for a down payment? Want to help cover daycare expenses? Instead of writing a check, transfer stock into their account.
When you transfer stock, there is a carryover in basis. That means if you bought XYZ stock for $50 and now it’s worth $250, there is still a $200 unrealized gain that will be realized when they sell.
Why do it? This works in a situation of tax arbitrage. In English, this works if their capital gains rate is lower than yours.
What to know about tax rates
While many people fall into the 15% capital gains bracket, you can end up paying 0%, 15%, 18.8% (net investment income tax) or 23.8%, depending on what your taxable income is.
Many states also apply their income tax rate to capital gains. In an ideal scenario, you’re giving to kids who are in school or at the beginning of their careers and have capital gains rates of zero.
However, it’s still a win if their rate sits anywhere below yours.
Here are the capital gains brackets without the net investment income tax, which is what adds that 3.8% for the top two brackets:
|
Tax Rate |
Unmarried Individuals, Taxable Income Over: |
Married Individuals Filing Jointly, Taxable Income Over: |
Heads of Households, Taxable Income Over: |
|
0% |
$0 |
$0 |
$0 |
|
15% |
$49,450 |
$98,900 |
$66,200 |
|
20% |
$545,500 |
$613,700 |
$579,600 |
It’s important to point out that these thresholds are based on taxable income, which is gross income less deductions. If your unmarried daughter is making $75,000, there still might be an opportunity here.
If you’re nodding, raising your hand or both, press pause.
What’s the gift’s purpose?
I often caution clients that giving money can be a rope, or it can be quicksand. Most of this depends on the child, and you probably know which it is.
However, it also depends on the gift’s purpose. I am a fan of helping with one-time expenses or expenses on a finite timetable. That’s why I mentioned down payments and daycare.
I am not a fan of gifts without an intended goal. Those tend to disappear or reappear in the form of something that gets parked in a garage.
