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A Profitable Gifting Opportunity
For Some Families |
This is an important year for taxpayers wanting to reduce their taxable estates or give appreciated assets to their loved ones. Why? Because the federal income tax rate on long-term capital gains and qualified dividends is now zero percent for people in the 10 percent or 15 percent federal income tax rate brackets.
So if you have children, grandchildren, elderly parents or other loved ones who are in the bottom two tax brackets for 2008, you might want to give them appreciated stock or mutual fund shares. Then, they can sell the investments and pay zero percent on the gains--assuming the shares have been held for more than one year. For purposes of passing the more-than-one-year test, the recipient combines his or her holding period after the gift with your holding period before the gift.
Giving away stock that pays dividends can be another smart strategy. As long as the recipient is in the 10 or 15 percent rate bracket, the dividends will be free from federal income tax.
This profitable opportunity is available from 2008 though 2010 -- unless Congress changes the rules, which could easily happen. So you may want to take advantage of the zero percent rate on long-term gains and dividends this year. Next year might be too late.
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Can a Couple with $100,000 Salary Pay Zero Percent Capital Gains Tax?
Let's say your adult daughter is a married joint filer with two dependent children and the following information for the 2008 tax year.
$100,000 salary minus
10,000 for 401(k) contribution at work
16,000 in itemized deductions
14,000 for 4 personal exemptions of $3,500
$ 60,000 taxable income
So your daughter could have up to $5,100 of long-term capital gains and/or qualified dividends this year without owing federal tax. Reason: She and her spouse's total taxable income, including the gains and dividends, would be $65,100 or less. Therefore, their taxable income would be in the 15 percent bracket, which translates into a zero percent federal rate on long-term gains and dividends (they might owe state income tax). Any additional long-term gains and dividends would be taxed at the maximum 15 percent federal rate. | However, before you start handing out valuable shares -- or assume your loved ones don't qualify for this tax break -- read the details below.
Gift and Estate Tax Consequences
The strategy is to give away stocks and mutual fund shares that: have appreciated, pay dividends, or both. That way, your gift recipient can take advantage of the zero percent tax rate. But there are other considerations.
Under the annual federal gift tax exclusion privilege, you can give away assets worth up to $12,000 during 2008 to as many recipients as you want without any adverse gift or estate tax consequences. In other words, gifts up to $12,000 won't reduce your $1 million federal gift tax exemption or your $2 million federal estate tax exemption.
Even better, a married couple can jointly give away up to $24,000 without any adverse gift or estate tax consequences. If you're not worried about using up part of your gift and estate tax exemptions, you can give away more.
Income Tax Consequences
As mentioned earlier, the zero percent rate only applies to long-term capital gains and dividends received by those in the 10 or 15 percent federal tax brackets. But your gift recipient can be doing well financially and still be in the 15 bracket.
For example:
- A married man files jointly, has two dependent kids, and claims the standard deduction for 2008. He and his spouse could have up to $90,000 of adjusted gross income (AGI), including long-term capital gains and dividends from securities received as gifts, and still be in the 15 percent bracket. Their taxable income would be $65,100, which is the top of the 15 percent bracket for joint filers.
- A divorced woman uses head of household filing status, has two dependent kids, and claims the standard deduction for 2008. She could have up to $62,150 of AGI ($43,650 of taxable income) and still be within the 15 percent bracket for heads of households.
- Single adults with no kids, who claim the standard deduction in 2008, can have up to $41,500 of AGI ($32,550 of taxable income) and still be in the 15 percent rate bracket.
- If your gift recipient itemizes deductions, his or her 2008 AGI (including long-term capital gains and dividends from securities received as gifts) can be even higher, without being pushed out of the 15 percent tax bracket. The same is true if the recipient has "above-the-line" deductions. That's because the AGI figures quoted above are after subtracting these write-offs, which include deductible retirement account contributions, health savings account contributions, self-employed health insurance premiums, alimony payments to an ex-spouse, and moving expenses.
Watch Out for the Kiddie Tax
If the Kiddie Tax applies to your child or grandchild for 2008, some of his or her investment income (including long-term capital gains and dividends from securities received as gifts) will be taxed at his or her parent's marginal federal income tax rates--assuming those rates are higher.
Specifically, the parent's marginal federal rate on 2008 ordinary income, such as interest and short-term capital gains, could be as high as 35 percent. The child's or grandchild's rate on ordinary income is probably only 10 percent or 15 percent.
The parent's marginal federal rate on 2008 long-term capital gains and dividends is probably 15 percent. The child's or grandchild's rate is probably zero percent.
So avoiding the Kiddie Tax is a good idea, when possible. Fortunately, the Kiddie Tax applies this year only when all four of the following requirements are met:
 Requirement 1: One or both of the child's parents are alive as of December 31, 2008 and in a higher marginal federal income tax bracket than the child.
Requirement 2: The child doesn't file a joint return.
Requirement 3: The child's unearned income exceeds $1,800 for 2008 and he or she has positive taxable income after subtracting applicable deductions. If the threshold is not exceeded, the Kiddie Tax doesn't apply. If the threshold is exceeded, only unearned income in excess of $1,800 is hit with the Kiddie Tax.
Requirement 4: The child must fall under one of the three age rules explained below. In all cases, it makes no difference if the child is claimed as a dependent on someone else's tax return.
If the child is under age 18 on December 31, 2008, the Kiddie Tax applies if the other three requirements are also met for 2008.
If the child is age 18 on December 31, 2008, and he or she doesn't have earned income that exceeds half of his or her support, the Kiddie Tax applies if the other three requirements are also met for the year. If the child or grandchild is a student, support does not include amounts received as scholarships.
If the child is age 19 through 23 at year end and: (1) is a student and (2) doesn't have earned income that exceeds half of his or her support, the Kiddie Tax applies if the other three requirements are also met for 2008. Your child or grandchild is considered a student if he or she attends school full-time for at least five months during 2008. Support does not include amounts received as scholarships.
Conclusion: This article explains how to take advantage of zero percent federal income tax on 2008 long-term capital gains and qualified dividends. However, consider the Kiddie Tax rules if your gift recipient will be younger than age 24 on December 31, 2008. For those who will be 24 or older on that date, the Kiddie Tax rules do not apply, and they may benefit from the zero percent rate this year.
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