03 Mar Tax differences with gifted or inherited stock

Q. My father owns two blue chip stocks worth $100,000. He has owned these for well over 30 years, and he says he has paid taxes on the dividends every year. Rather than get hit with a capital gains tax, he’s thinking of gifting the stock to his six grandchildren. He is asking what the ramifications for taxes and/or cost basis if he gifts these to his grandchildren by changing ownership. If he does while he’s alive, what does this do to the grandkids for taxes/cost basis, or should he pass the stocks upon his demise?
— Tax curious

A. Your dad has several options, and they all have some kind of tax ramification, but he may find some more attractive than others.

Before we talk about your dad’s choices, let’s talk cost basis and capital gains tax.

The cost basis is the price that the your dad paid to purchase the stock plus any other costs such as commissions or broker’s fees, said Shirley Whitenack, an estate planning attorney with Schenck, Price, Smith & King in Florham Park.

When the stock is sold, the tax liability is determined by the cost basis and the sales price, Whitenack said.

“If the stock is sold for more than the original cost basis, the difference will be taxable as a capital gain in the year of the sale,” she said. “If the stock is in a qualified savings account, such as an IRA, 401(k) or 529 plan, taxes are incurred only when withdrawals are taken.”

Whitenack said stocks held for more than a year are considered long-term and are taxed at lower rates than ordinary income, and long-term capital gains are taxed at different rates depending on the taxpayer’s tax bracket.

In 2016, the tax rate on long-term capital gains is 20 percent for those in the top bracket, 15 percent for single filers with taxable income up to $415,050 and married filing jointly with taxable income up to $466,950, and zero percent for those in the 10 or 15 percent tax brackets, Whitenack said. Single tax filers earning more than $200,000 and joint filers earning more than $250,000 may also have to pay a 3.8 percent “Net Investment Income Tax.”

If your father gifts the shares to his grandchildren, the ownership of the shares would be based on the age of the grandchildren, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.

If they were minors, the shares would need to be held in custodial form, Hook said. If they are not minors, they can own the shares in each of their own names.

Hook said gifting shares while he is still alive will not eliminate the capital gains when the stock is sold.

“The person or persons receiving appreciated stock assume the same cost basis as the person who gave the stock,” Hook said. “So in your case if the grandchildren sold the stock, they would have a capital gain.”

Further, Hook said, if they were under age 19 or full-time students under the age of 24, a portion of the tax rate on the sale of the stock may be taxed at their parent’s tax rate, Hook said.

It’s the so-called kiddie tax.

“The rules are complicated but generally speaking, children under the age of 19 or full-time students under the age of 24 are allowed to exclude the first $1,050 of unearned taxable income from their tax return,” Hook said. “The next $1,050 is taxed at the child’s rate. Any amounts over that amount are taxed at the parent’s tax rate.”

Depending upon the individual circumstances, there may be little or no tax savings achieved by giving the stock to the grandchildren, Hook said. A higher rate could possibly be paid if the parents of the grandchildren are in a higher tax bracket than the grandfather.

Instead, if the stock is gifted upon his death, the grandchildren would receive the stock with a cost basis equal to the value at the date of death, or if elected by the executor, the value nine months later, known as the alternate valuation date, Hook said.

This is called a stepped-up basis.

“Presumably most if not all of the gain in the stock immediately prior to his death would be eliminated,” Hook said.

Also remember that any funds gifted to minors may count more heavily in financial aid formulas when the kids apply to college.

What’s best for your dad and for his grandchildren will depend on their specific circumstances.

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This story was first posted in March 2019.