This issue’s “Tax Tips” article details why taxpayers should consider giving appreciated stock to their children to minimize capital gains taxes, explains how to deduct bad debt and covers why “net, net gifts” are now a more viable strategy.
Shift capital gains to your children
Giving appreciated stock or other investments to your children can minimize the impact of capital gains taxes. For this strategy to work best, however, your child must not be subject to the “kiddie tax.” That tax applies your marginal rate to unearned income received by a dependent child under the age of 19 (24 for full-time students) in excess of a specified threshold ($2,100 in 2016).
Here’s how it works: Say Bill, who’s in the top tax bracket, wants to help his daughter, Mollie, buy a new car. Mollie is 22 years old, just out of college, and currently looking for a job — and, for purposes of the example, won’t be considered a dependent for 2016. Even if she finds a job soon, she’ll likely be in the 10% or 15% tax bracket this year. To finance the car, Bill plans to sell $20,000 of stock that he originally purchased for $2,000. If he sells the stock, he’ll have to pay $3,600 in capital gains tax (20% of $18,000), plus the 3.8% Medicare surtax, leaving $15,716 for Mollie. But if Bill gives the stock to Mollie, she can sell it tax-free and use the entire $20,000 to buy a car. (The capital gains rate for the two lowest tax brackets is 0%.)
The right way to deduct bad debt
If your business plans to take a partial bad debt deduction, consult your accountant to be sure you record it properly. Recent IRS guidance illustrates the right — and wrong — ways to do so. In an example provided in the guidance, a taxpayer wasn’t entitled to partial bad debt deductions because the taxpayer hadn’t charged off the amounts in question during the relevant tax years. Simply setting up or adding to a reserve account isn’t enough. The purpose of the charge-off requirement is to “perpetuate evidence of a taxpayer’s election to abandon part of the debt as an asset.”
Court victory for “net, net gift” strategy
It’s well established that a net gift — where the recipient agrees to pay the resulting gift tax — allows you to reduce the gift’s value for gift tax purposes by the amount of tax the recipient pays. The U.S. Tax Court has now also given its stamp of approval to the “net, net gift” strategy.
That’s where the recipient also assumes the estate’s potential estate tax liability under Internal Revenue Code Section 2035(b). This section requires that, if you die within three years after making a gift, any gift tax paid on the gift be included in your estate, which could create an estate tax liability. The court’s decision allows you to reduce the value of net, net gifts by the actuarially determined value of the recipient’s contingent liability for this potential additional tax on your estate.