So, You Want To Give Your Child Or Grandchild A Gift?

When you're lucky enough to be able to afford to help your children pay for their children's college education, then you've hit the jackpot: Not only are you wealthy enough to give away some of your savings, but you've lived long enough to help a second generation of your lineage get a good start in life. However, the hassle of knowing how to give a gift is enormous.

Is it better to give a stock, or sell it yourself and give the cash? The answer is not always so simple because of tax implications. The best way to learn the complex rules governing such a seemingly simple financial affair is through scenario planning.

Let's look at the easiest, most common scenario first. It's no secret that giving a child age 14 or older an appreciated asset can be tax-wise. You might be in the 35% income tax bracket, while the child could be in the 5% bracket. If you sell securities or other assets and reap a profit after holding them a year, you'd pay a 15% gains tax, while the child would pay a 5% gains tax.

This strategy is a no-brainer for gifts to teenagers, students and young adults that have not yet found a career. But it won't work once a child gets older and is working at a job that pays well. So what do you do when you have older children that are breadwinners? What's the best way then to give a gift?

The answer: it depends on the prospects for the stock, whether it's worth more or less than you paid for it, and the financial circumstances you and the child are currently facing. Consider the following scenario.

• You're considering gifting 100 shares of stock selling for $75 a share
• You purchased the shares some years back for $100 a share

To make the gift, should you sell your shares and give the $7,500 in cash, or simply give your child the stock? Here are the factors to weigh:

• Can you use a capital loss this year? A capital loss of up to $3,000 can be written off dollar for dollar against any capital gains. In this case, your $2,500 capital loss can be used to avoid paying tax on an equal amount of profit. This amounts to a few hundred dollars of tax savings and may not be material in giving larger gifts.
• What is the outlook for the stock? When you transfer ownership of an asset, the recipient of your gift inherits your tax basis-with a catch. The IRS doesn't let your child benefit from a tax loss. Your child cannot write off your $2,500 loss. Your child can't use your "cost-basis" to take a loss.
• The IRS does let your child benefit from your cost basis if the stock rises and is sold for a gain. When your child sells the stock, he or she will owe tax only on any gain above his or her $100 a share "basis." In this case, your child would not pay any tax on the first $25 of appreciation.

Some guidance: If the stock seems poised to recover, giving the actual shares may make sense, because your child wouldn't be taxed on the first $2,500 of appreciation. But if the stock is going nowhere, you're probably better off selling now and using the loss to cut your taxes.

Now consider a second scenario, a gift of an appreciated asset:

• You're considering giving your child 100 shares of stock selling for $125 a share.
• You bought at $100 some years ago.
• Should you sell the stock and give your child the cash? Or should you directly give your child the shares? The factors to weigh:
• If you sell, your $2,500 profit will be taxed at the 15% rate for capital gains.
• If you give your child the shares, your child's basis will be the same as yours, $10,000.
• The prospects for the stock.
• Where else could that money be put? If the stock is fully priced, it may be smart to sell, pay the capital gains tax and give the cash to your child, who can invest the proceeds in something else.
• If you gift the shares instead, and the share price drops, say from $125 to $110, not only will your gift have lost value but your child is on the hook for a $1,000 capital gain.

If you're making a large gift, you also need to consider potential gift-tax consequences. In 2004, you may give anyone up to $11,000 (or $22,000, with your spouse) without owing gift tax. Give more than that, and you must file a gift-tax return, with the excess charged against your lifetime exemption of $1 million. Whether you give stock or cash normally doesn't affect this calculation, because the stock is valued at its fair market value at the time of the gift.

If you've exhausted your lifetime gift exemption and must pay gift tax on the transfer of shares-and if their value at the time of the gift exceeds your basis-then you're allowed to increase the basis by a portion of the gift tax you paid. That reduces the potential capital gains liability of the gift's recipient.

8/05/2004 © AdvisorSites, Inc. 2001. All Rights Reserved.