Do you have children in college or starting soon? Will you be writing large tuition checks soon? Do you have appreciated stock you want to sell but for the large capital gain tax you will owe on such sale? There may be a way for you use the stock appreciation to pay for your children’s education while minimizing the capital gains tax you need to pay.
If your income is over certain minimal levels, you don’t get a tax deduction or credit for paying college tuition. There really is no special college education “tax shelter” out there. While the lower income taxpayers qualify for tax credits and college grants, ordinary middle class taxpayers trying to send their kids to college have to find a way to pay college tuition. Often this means selling investments.
You probably won’t be able to completely avoid paying capital gains tax on the sale of appreciated stock. But if you gift the stock to your children over age 18 and have them sell the stock, they will pay capital gains tax at the lowest possible rates.
For taxpayers in the highest income tax bracket, the capital gains rate is 20%. For taxpayers in the 25% to 35% brackets, the capital gains rate is 15%. For taxpayers in the 10% or 15% bracket the capital gains rate is zero. The 15% bracket includes taxpayers whose annual income does not exceed $36,900. This would probably describe most college students.
A few things to remember:
The annual gift exclusion is $14,000 per donee per year. You and your spouse can each make a gift of up to $14,000 to each child with no gift tax and no obligation to even file a gift tax return. Together you can gift the child $28,000 of stock under the annual gift exclusion.
If only you own stock, you can still gift up to a combined $28,000 by first gifting $14,000 of stock to your spouse. Your spouse can then “re-gift” the stock to the child. It is also possible for you to gift $28,000 without first gifting the stock to your spouse. But this requires you to file a gift tax return to report the joint gift.
The lifetime gift / estate exemption amount for each person is now over $5,000,000, so you and/or your spouse can gift more than the annual exclusion amount without paying any gift tax. The only additional requirement is that you must file a gift tax return to report the gift. Filing a gift tax return is not a bad idea in any event since filing the gift tax return starts the running of the 3 year statute of limitations. After 3 years the IRS cannot challenge the gift or the valuation of the stock.
In order for this to work, the stock must be transferred to an account in your child’s name, and then sold. You don’t avoid the capital gain tax if you sell the stock and then give the proceeds to your child. The child does not have to be under age 18 at the time of the gift, but the child must be over the age of 18 when the stock is sold so that the capital gain is taxable to the child at the child’s capital gain rate.
One note of caution. Once you do the stock gift, your child owns the stock and can sell or not sell as he or she pleases. So very important to have a discussion with your child about the value of a good education and what you expect of them regarding the stock gift and subsequent sale.
Please call or email one of our tax or estate planning attorneys if you have any questions or comments about gift taxes or income taxes at 937-223-1130 or Jsenney@pselaw.com.