02 Mar Tax-smart gifting to a grandchild

 Q. Is it good idea to gift appreciated mutual funds or stocks? For example, I could gift an exchange-traded fund worth $14,000 to my grandkid, or sell it and give $14,000 after paying 23 percent this year. What’s better?

A. That depends.

A gift to a grandchild is usually made as part of an overall estate planning strategy, said Brian Power, a certified financial planner with Gateway Advisory in Westfield.

The initial reason you’re giving the money away is to save your heirs from paying estate taxes at your death. But there will be potential capital gains tax issues depending on what is done with the stock once it’s gifted, Power said.

“If the appreciated stock/mutual fund is gifted and sold immediately, the gain on the sale would be included in the grandchild’s income but considered `unearned income,’ he said “If the child is under the age of 18, the first $1,050 of unearned income is tax free and the next $1,050 of unearned income is taxed at the grandchild’s tax bracket, which is most likely less than the 23 percent capital gains rate of the grandparents.”

All unearned income above $2,100 is taxed at the parent’s tax bracket, he said, and the parent’s bracket could be in the same bracket as the grandparents. The capital gains tax savings are definitely there, but they’re not significant, Power said.

If the gift is made and the stock/mutual fund is never sold, then the tax doesn’t need to be paid, or, it’s deferred until when the grandchild sells the shares in the future, Power said.

But you should also consider the investment risk of not selling the stock/mutual fund right away.

“The grandparent should keep in mind that at the moment — Obama wants to change this — if the shares are left to the grandchildren at the grandparent’s death, the shares cost basis get a step up to the current market value,” Power said. “And if the grandchild sells the shares after inheriting it, they won’t have to contend with a capital gains tax.”

Because of this, Power said, many people will gift cash to the grandkids and leave highly appreciated assets to their heirs at death, or they gift assets that are highly appreciated to charities because the charity could sell the shares and avoid paying the capital gains tax.

Power said if the shares represent a very large portion of a person’s investments and they’re concerned about the concentration risk, selling to protect the family’s legacy may be more important than the tax considerations.

“In this scenario, the cost basis may be so low that having the grandparent sell it or the grandchild sell it, after the gift, may not be much of a savings taxwise,” he said. “If that’s the case, the grandparent can sell it and pay the capital gains tax.”

Power said paying the capital gain tax would be another way to reduce their estate and at a 23 percent rate, would be less than the estate tax rate. The top federal rate is 40 percent and the top New Jersey rate is 16 percent, giving you a total of 56 percent if you don’t make the gift at all.

Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Boonton, said he has a standard response when someone asks if they, or the person they’re gifting to, should pay the taxes.

“My response is always have the other person pay, especially if you are giving them $14,000,” he said. “But who cares! Out of the $14,000 that you gave them, part is your original cost, which is tax-free. Only the gain is subject to taxes, and they can control the gains by selling systematically over time to be under the $2,100 threshold.”

Lynch doesn’t think it’s likely they will object to having to pay the tax.

“If they object, give me the appreciated stock and I will have no problem paying the taxes on the gain for you,” he said.

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This story was first posted in March 2015.