Gifting Effectively: Don’t Forget Taxes and Investments!

Many Americans believe that there are two U.S has two tax codes – one for the rich and one for the poor. Actually, there are two U.S. tax codes, but for the informed and the uninformed. Our team at FEG regularly meets mistakes – or at the very least missed opportunities – simply because taxes were overlooked in the decision process and appropriate actions were not taken given the circumstances.

A good example of this came when our team had a meeting with a set of generous grandparents who wanted to pay for their grandchild’s college tuition. What a wonderful blessing! This couple had the best of intentions, their CPA answered the questions using the data he had available, and the parent (father of the daughter) conducted research on Google related to gifting tuition.

The CPA told the couple they could indeed pay the tuition and was naturally correct – schools do no care who writes the check. The son discovered that his parents could give up to $15,000 to the grandchild which was partially correct. In this scenario, what was missed in the analysis was how investing, taxation, and desired results collide.

The grandparents are indeed limited to making a gift of $15,000, individually, to anyone – blood relation or not – provided it is a gift of present interest. In other words, the recipient can use the gifted money for any reason. However, there are important exceptions that affected the gift! Checks sent directly to educational institutions or medical services are not limited by the $15,000 limit. The grandparents could have paid the entire $25,000 tuition to the university if they desired.

Now here is where taxes and investing meet. For years, the grandparents had held onto a stock that did not pay a dividend (thus not listed anywhere on a tax return) and there was a sizable capital gain from over two decades of appreciation. There is no way the CPA functioning as a tax professional independent from the financial planner would know about the existence of this stock. Should more questions have been asked? Perhaps, but that is not the way most people think.

So the grandparents wrote the $15,000 check to his son to pay for the daughter’s education as many people making the same gift would have. Now understand there is nothing wrong with that approach, but it is far from the most efficient use of the tax code.

The son is in the 12% marginal tax rate meaning that he will pay no taxes on long-term capital gains assuming the gain from a sale of stock will not push him to a higher bracket. The grandparents should have gifted the shares of the stock (up to $15,000 in value) and the son’s tax basis in the gift is the same as the father’s ($1,200 in this case.) The holding period – long term – also transfers. The son could sell the gifted stock, pay no taxes and then pay $15,000 of his daughter’s tuition.

While the approach described above sounds complex, it would have saved more than $2,000 in unnecessary taxation. Excess taxation due to being uninformed is simply unacceptable in a world where every dollar counts.

 

Joseph A. Clark is a Certified Financial Planner and Managing Partner of The Financial Enhancement Group, and an SEC Registered Investment Advisor. Contact Joe at yourlifeafterwork.com or 800-928-4001. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.  World Equity Group, Inc. does not provide tax advice.  For tax advice consult with a qualified tax professional.

 

 

 

 

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