Using gifting to accomplish goals and reduce taxes

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When we work with clients to build and maintain their financial plans, we do so while keeping in mind the potential tax ramifications of our recommended actions and strategies. We listen to what the client wants to accomplish and then offer options that we and the client are comfortable with, from a planning and tax perspective.

Clients often tell us they would like to provide financial help to a family member or friend. Typically, their first idea is to simply write a check, which is usually the easiest and quickest way to give. But is it the most effective? Cash may be fine for relatively small gifts, but when the giving involves a few or many thousands of dollars there may be more tax efficient alternatives.

For instance, gifting appreciated securities (stocks, bonds, or mutual funds) to a friend or family member who is in 10% or 15% marginal tax bracket can result in meaningful tax savings. This is because the federal long-term capital gains tax rate for taxpayers in these two marginal tax brackets is 0% (although state tax may be owed).[i] This gifting strategy minimizes or eliminates the recipient’s capital gains tax. The giver also benefits because they have not incurred any capital gains tax, whereas if they sold the appreciated security and gifted the proceeds they likely would have incurred a taxable capital gain.[ii]

How is this concept applied in the real world? We recently worked with a married client couple to implement a similar gifting strategy to help their daughter with repaying her student loan. After we talked with the client about their investment and 2013 tax situation we found that the clients’ income likely will be high enough to land them in the 33% federal marginal tax bracket and also subject them to the 3.8% Medicare tax on unearned income. Their situation meant that any federal long-term capital gains incurred would be taxed at 18.8% (15% long-term capital gains plus 3.8% unearned income Medicare tax) plus 7.75% for NC state income tax. The tax consequences would be even higher if the loan repayments were made using income from their current paychecks because those dollars will be taxed at 33% at the federal level and 7.75% at the NC state level. Their daughter however, will not be impacted by the Medicare tax and she will fall into one of the lower federal marginal tax brackets.

We collectively agreed that gifting appreciated stock was a more tax efficient way to help with the loan than tapping cash from their savings, selling the stock and gifting the proceeds or using current income from their jobs. Shortly thereafter, the clients gifted appreciated stock purchased many years ago (thus qualifying it for long-term capital gains treatment) to their daughter. She then sold the stock and is now using the proceeds to reduce the loan balance.

The daughter likely will be in the 15% federal marginal tax bracket for 2013, which means that her long-term capital gains tax on the stock should be zero. Additionally, because she lives in a state that does not tax long-term capital gains, she will be able to apply the entire gift to the student loan rather than using a portion to cover state tax liability. If her employment income plus the gift’s realized capital gains push her into the 25% marginal tax bracket, then most of the long-term capital gain will still be tax free because the majority of the gains will be applied to filling up the 15% tax bracket. The small portion of capital gains that spill into the next highest tax bracket will taxed at the 15% federal long-term capital gains rate.

In the end, the client met their goal and the strategy provided a tax savings. The capital gains tax the daughter has to pay, if any, will be significantly lower than the tax the clients would have incurred had they sold stock and gifted the resulting cash. This is one example of the strategies and planning options we provide to clients at Woodward Financial Advisors. Please contact us if you have questions about gifting strategies or questions about how we can help you plan.


[i] A long-term capital gain is realized when shares are sold more than one year from their purchase date. A short-term capital gain is realized when shares are held one year or less before being sold. Short-term capital gains are taxed at ordinary income rates, which for 2013 range from 10% and 43.4% (which includes the 3.8% Medicare Tax).

[ii] When using this strategy it is important to remember the ‘kiddie tax’ rule. The rules states that children under age 24 who are full–time students and are claimed as dependents on their parents’ tax return might have a portion of their investment income taxed at their parents’ rate, which is likely higher than the child’s tax rate.

About Austin Brown

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