Spoiling one's grandchildren is an ancient and noble tradition -- Mom and Dad provide the youngsters with rules and structure, while Grandma sneaks them extra dessert and lets them stay up past bedtime. And if their financial situation allows it, grandparents may move some wealth across the generations, too, even before the point at which inheritances are dealt with. That's the sort of move that one might expect would be both smart and simple from a tax perspective: Most kids have little to no income, so they'd be in an extremely low tax bracket.
But as Motley Fool Answers hosts Alison Southwick and Robert Brokamp explain, that's not the full picture. You can give it away, but Uncle Sam still wants his share. In this mailbag segment of the podcast, they and Megan Brinsfield, director of Foolish Planning with our sister company, Motley Fool Wealth Management, break down the tax ramifications.
A full transcript follows the video.
This video was recorded on March 26, 2019.
Alison Southwick: Let's move on to our next question from Joe. "What are the tax benefits, limits, or ramifications of transferring stocks to my granddaughter?"
Megan Brinsfield: Great question from Joe! And a generous one. He sounds like a nice grandpa. I think one of the main misconceptions that people have when they transfer stock to someone else is that maybe they'll get a better tax rate if they do that. When he mentioned "granddaughter," that stuck out to me as potentially someone who is not yet a full adult. You think of children having better tax rates because they're not earning any money and they get the benefit of a deduction and all of that good stuff.
But then you've got the Kiddie Tax that comes in, and it's like a dark cloud over that situation, because if you have unearned income as a minor -- so if you're under 18 or if you're a full-time student and under 24 -- that unearned income is taxed at a beneficial rate only so much. So the first $1,050 is not taxed, the next $1,050 is at the student's or child's tax rate, and then anything beyond that is treated as if it was taxed inside a trust. That used to be it will get taxes at the parents' rate.
With this latest tax reform, the Kiddie Tax actually takes on the trust tax brackets, which are much lower, so any unearned income over those initial thresholds are going to be taxed at pretty much the highest capital gains tax rate when that person sells.
Robert Brokamp: Right. When you say tax rates on trusts are lower, what you really mean is it does not take much income to get to those higher brackets.
Brokamp: It's surprising, really. Trusts can be, actually, very tax inefficient.
Brinsfield: Exactly. The highest rate for an individual is in the hundreds of thousands of dollars. The highest tax rate for a trust -- you'd get there over $12,500 income.
Southwick: Oh, goodness! Wow!
Brokamp: Yeah. Another consideration people often think of when it comes to gifting is the annual gift tax exclusion, which for this year is $15,000. A lot of people think, "If I give more than that, I owe taxes." That's not true. It means you have to file the gift tax form, which is Form 709, and that just eats into your lifetime unified gift estate exemption, which is $11.4 million per person. Am I getting this right? I always have to look at Megan to make sure I get all this right.
Basically it just lowers that. Instead of being able to give $11.4 million when you die, it's $11.3 million something, something, something.
Southwick: $11.399999 million...
Brokamp: So people don't have to worry about that. You just have to make sure you file that form.
Southwick: Do you have any recommendations for Joe? What should he do if he wants to give stock to his granddaughter?
Brinsfield: If the granddaughter receives the stock, she can hang onto it until [her age is] beyond those Kiddie Tax rules and sell it when she's a young adult, probably still in a very beneficial tax bracket. The other thing he could do -- which is a little morbid -- is to hang onto that stock until he passes away, and then there's a step-up in basis and his granddaughter -- or whoever he chooses -- would receive that stock with no gains built in at all. It would be tax free if they received it and immediately sold it.
Southwick: Isn't it a pain in the patute to transfer stocks to someone?
Brokamp: Generally, no.
Southwick: You just go to your broker and you're like, "I want to give these five shares of Google to this person's brokerage account"?
Brokamp: Generally speaking.
Southwick: Oh! Can I do that with anyone?
Brokamp: Sure, you can give me some if you'd like.
Southwick: No, seriously. Can I just be like, "I want to give you some of my stock." I could just do that?
Brokamp: Sure. You'd have to open an account.