What to do with that appreciated stock that you own? Sure, you could sell it and reap the financial benefits, paying taxes at a preferred 15% rate (assuming a long-term holding period). But then what to do with the money? It just might go to the kids to pay for school or college expenses, or that first vehicle, or any number of things. If that's the case, you might want to consider simply gifting the shares to the kids and saving some tax dollars in the meantime.
This technique, known as "income shifting" in tax-speak, gets funds to your kids while cutting Uncle Sam out of some of the tax dollars. How? The new tax law reduces the tax rate on long-term capital gains and dividends to a minuscule 5% when the taxpayer is in the 10% or 15% rate bracket. If you're a high bracket parent (anything over the 15% bracket, but the greater your bracket, the greater the tax savings), gifting appreciated stock to a child or any other low-bracket relative will shift the tax burden from the high-bracket parent to the low-bracket child.
As long as the combined holding period of the parent and the child are greater than one year, the child can sell the appreciated stock and pay only a 5% tax on the long-term gain. And, if this is a dividend-paying stock, the child will also reap the benefit of a 5% tax on any qualified dividends received.
Take the case of Brian, who is in the 33% bracket. His son Jason is his last year of high school, and is looking for a few dollars to pay for college. Brian owns a stock that he originally purchased for $3,000 that is now worth $9,000. In other words, the shares have appreciated about $6,000. Brian could sell the stock, pay about $900 on the sale, and give the remainder of the funds to Jason for college tuition.
Or Brian could instead gift the shares to Jason. Jason could then sell the shares and reap the $6,000 profit. It's quite possible, depending on Jason's other income, that he could get away with paying no tax on this gain. But let's assume that Jason does have some other income earned from his part-time job, but still resides in the 15% bracket. That being the case, Jason's tax on this gain would be only $300 -- a tax savings of $600.
There might be other tax savings lurking. By gifting this income to Jason, he might be able to show that he provided more than 50% of his own support, and will be able to claim his personal exemption on his own tax return. Because of Brian's income, his personal exemption for Jason is "phased out" and he receives no tax benefit whatsoever.
And that's not all. Since Jason isn't being claimed as a dependent on Brian's return, Jason will likely be eligible to claim the Hope Scholarship or Lifetime Learning Credit on his personal tax return to realize even more tax savings. Even if Jason is Brian's dependent, Brian can elect to forego claiming Jason as a dependent, since Jason's personal exemption gives Brian no tax benefit (because of the personal exemption phase-out rules noted above). So while Jason won't be able to claim himself as his own personal exemption in this case, it will still open the door for Jason to claim the education credits that are of no benefit to Brian because his income above the eligibility limits.
Obviously, all of this comes together best when Jason has enough taxable income in order actually owe federal taxes and utilize the credits and deductions available to him. So when a gift of appreciated stock is contemplated, all of the other income issues should be closely monitored -- including how increasing a student's assets will affect financial aid eligibility.
But using this "income shifting" technique can be very powerful from a tax-saving standpoint. And remember that such a gift doesn't have to go exclusively from parent to child. So if you find yourself partially supporting a sibling or parent in a lower tax bracket, keep this technique in mind.
Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.
