3 Tax-Smart Ways to Help Your Children
Listen up parents: it costs over $230,000 to raise a child from birth through age 17, according to the latest spending report from the USDA[1]. Faced with a six-figure commitment, you might as well do your best to mitigate taxes while providing for your children.
Giving gifts to children has long been an advantageous estate planning strategy for affluent families. Because gifted assets are removed from your estate, they are not subject to the hefty 40% estate tax rates. The calculus changed significantly with the new tax law passed in 2017, as the Federal estate tax is now only triggered for assets above $22 million, sheltering most families from any impact. State estate tax rules vary however, for example in Illinois the estate tax is levied on assets over $4 million.
For the 2021 tax year, you can gift $15,000 per person, or $30,000 per couple, to any individual.
Gifting is still a useful strategy, as future estate tax law is unknown. In addition, gifting strategies can help you pay less tax in a current year, increasing the value of both your gift and your portfolio. Before you gift your child cash, stop and consider these three tax-saving alternatives:
1. Gift Stock Over Cash
Gifting appreciated stock can be a great alternative to simply giving your children cash. The reason is that by giving away stock that has appreciated in value (and held at least 12 months), you do not need to recognize the capital gain in the process. By gifting appreciated stock, you avoid any long-term capital gains tax liability that you would otherwise owe in the future.
Any capital gain liability does transfer to the recipient of your gift – there is no “step-up” in cost basis when gifting stock; this occurs only at death. So it helps to know more about your child’s tax situation. For example, this strategy works best if your child is in the 10% or 15% tax bracket, as these individuals have a long-term capital gains rate of 0%. Nonetheless, if your child is in a lower tax bracket than you, gifting appreciated stock will have a better result than selling stock and giving the cash.
Example of Gifting Appreciated Stock
If you were to gift old shares of XYZ stock that you bought for $20 per share and now has a market price of $120 per share, your child will receive your cost basis of $20. This means that they would have a $100 per share capital gain on which they owe taxes. However, if they are in a low enough tax bracket (10% or 15%), they may pay $0.00 in long-term capital gains. Had you gone ahead and sold the stock yourself, at the highest tax bracket, you would have paid up to 23.8% tax on the gain.
In addition to considering the step up in basis, you also might consider the holding period. For example, if you had held the stock for five years, the holding period would apply to your child and be considered long-term capital gains. You don’t want to gift stock you’ve held less than one year, as your child would have to pay the higher short-term capital gains.
In the instance that your child is in a higher tax bracket and you are too, gifting appreciated stock may be a strategy to avoid. In this instance, you might instead gift cash, or stock that has minimal appreciation. Remember, if you bequeath the stock after you pass away, the cost basis is “stepped up” to the value of the stock on the date of your death, meaning that they now have (from example above) a $120 cost basis per share, and thus no capital gain if they sell it immediately.
Other Considerations
Another consideration has to do with the age of your children. Steeper taxes apply to gifts that are made to young relatives. Gains from investments that exceed $2,200 and that are given to children under the age of 19 (or college students age 24 and younger) are taxed at higher trust rates.
2. Contribute to a 529 College Plan
A 529 plan is perhaps the most common method people use to save for college. A 529 plan is a state-sponsored education savings account that allows earnings to grow tax-free. This means that 100% of your growth can be used toward the tuition and is not whittled away paying annual taxes, which can have a big impact on bottom line. 529 plans also have a special rule which allow you to make a lump-sum contribution equal to five times the annual gift tax amount, up to $75,000 per individual or $150,000 per couple.
New to the tax law, in 2019 529 plan assets can also be used to pay for private school tuition for K-12thgrade, up to $10,000 per year. Check with your state’s plan first, as some states (including Illinois) have yet to embrace the new federal rules.
3. Gifting to a Roth IRA
Roth IRAs are a widely popular investment strategy and for good reason: qualified Roth IRA earnings are tax-free and there is no required minimum distribution (RMD), making these accounts a powerful tool for long term wealth building.
What many may not know is that children can make Roth IRA contributions if they have compensation. And these contributions can come in the form of a gift. So, if your 15 year-old daughter or granddaughter has earned $6,000 at a summer job, you can gift them up to $6,000 (the maximum annual contribution) to invest in a Roth IRA in their own name.
Next Steps
If you have grown your wealth to the point where you can afford to gift some of it away, well done! The decisions that you make on how you’d like to gift your wealth have many different tax implications, and we would love to be a sounding board for the gifting ideas you have, specifically as they relate to appreciated stock. You can reach us by calling (844) 377-4963 or emailing windgate@windgatewealth.com. You can also book an appointment online here.
[1]https://www.cnpp.usda.gov/sites/default/files/crc2015_March2017.pdf
