Another approach to reducing stock market exposure without incurring steep tax bills involves year-end gifts to family members. One way to use gifts in family tax planning is to transfer assets to youngsters such as your children or grandchildren. In 2015, the annual gift tax exclusion is $14,000. (See the article, “Year-End Estate Tax Planning,” in this issue for more details.)
Example: Gil and Karen Martin, who have three children, own stock funds that have appreciated sharply since the purchase dates several years ago. In late 2015, Gil gives $14,000 worth of stock funds to their son Nick, $14,000 of those shares to their daughter Patti, and $14,000 to their daughter Renee. Karen does the same. Thus, the Martins have reduced their stock market exposure by a total of $84,000 (six $14,000 gifts) without owing any tax and without having to ﬁle gift tax returns.
After such a gift, the recipient retains the asset’s basis (cost, for tax purposes) and holding period. Assume here that each $14,000 gift has an $8,000 basis, reﬂecting what Gil and Karen paid for the fund shares. Each child receives $28,000 of fund shares and would have a $12,000 long-term gain on an immediate sale of those shares.
Depending on the age of the children and their school status, the so-called “kiddie tax” rules might come into play. Those rules are complex, but the youngsters to whom they apply include full-time students under age 24. For tax code kiddies, any unearned income over $2,100 this year would be taxed at the parents’ rate. Thus, there would be little tax advantage for such gift recipients to sell the shares immediately.
On the other hand, children who have ﬁnished their education or reached age 24 generally are past the kiddie tax years. If so, they might sell the shares and owe 0% tax on all or part of the gains. Long-term capital gains are tax-free as long as taxable income is no more than $37,450 on a single tax return in 2015, or $74,900 on a joint return.
By the same logic, if Nick Martin is a 22-year-old student now, he can hold the appreciated shares until he ﬁnishes school or reaches age 24. At that point, Nick may be able to use the 0% tax rate on a proﬁtable sale.
Alternatively, if the Martin children are very young, they could simply hold on to the gifted shares, as well as any shares they receive in future years. With their long-time horizon, the youngsters might be able to ride out market volatility, see the shares appreciate in the future, and take 0% gains at some point.
In any case, the Martins will have reduced their stock market exposure without owing tax, and they’ll have helped their children build a college fund, pay oﬀ student debt, buy a home, or ﬁnd another use for the transferred shares.
Instead of (or in addition to) gifts to children, appreciated shares can be given to retired parents who might have modest taxable income. This plan can be especially attractive for taxpayers helping to support elderly relatives.
Example 2: Assume that the Martins are providing ﬁnancial help to Gil’s parents, who are living on a modest ﬁxed income. Gil and Karen could each give $14,000 of appreciated stock fund shares to Gil’s mother and $14,000 of such shares to Gil’s father by year-end 2015, for a total of $56,000. If those funds pay dividends, the senior Martins could hold onto the shares and probably owe 0% on the dividend income. The same 0% tax rules for long-term capital gains also apply to qualiﬁed dividends.
Alternatively, Gil’s parents could sell the gifted shares. Assuming the same basis as in example 1 ($8,000 per $14,000 of shares), their taxable gain would be $24,000, some or all of which could be taxed at 0%. The money could be used for retirement living expenses.