Gifting stock to friends and family members can be tricky — there are several ways investors can get tripped up and make a poor decision from a tax standpoint. Below are some considerations for financial advisers to ensure their clients are gifting appropriately.
Beyond pure benevolence, clients typically gift stock — whether a mutual fund, exchange-traded fund or individual security — with an eye to tax optimization, whether on the income-tax or estate-planning side.
Individuals can gift up to $15,000 each year tax-free to an unlimited number of recipients, courtesy of the annual gift exclusion, which is indexed for inflation.
For example, in April, Russell Wilson, quarterback for the Seattle Seahawks, gifted $12,000 in Amazon stock to 13 teammates for a total $156,000 gift. Mr. Wilson wouldn’t owe tax on these gifts, since each was below the $15,000 annual limit, and wouldn’t have to report the gifts to the Internal Revenue Service.
Let’s say Mr. Wilson later this year decided to give one of the teammates an additional $8,000 in stock, thereby exceeding the annual limit by $5,000. In this case, the excess $5,000 would be subtracted from Mr. Wilson’s lifetime gift-tax exemption, which allows an individual to gift up to $11.4 million tax-free during life.
One note: Gifts toward education and medical expenses don’t count toward the $15,000 annual limit. Mr. Wilson could theoretically pay for a teammate’s child’s college tuition or pay the teammate’s health insurance premiums without eating into his $11.4 million lifetime exemption.
For tax purposes, recipients of gifted stock inherit the original cost basis (share price) and holding period. Let’s say an investor bought stock for $5 a share and gifted the stock to a friend two years later, after it had grown to $10 a share. If the friend were to immediately sell the stock, there would be a capital gains tax on the $5 growth. Since the holding period is longer than a year, long-term capital gains rates would apply.
Clients may consider gifting stock to take advantage of a tax arbitrage. For example, a client subject to a 20% capital-gains tax may gift stock to a family member in the 0% or 15% tax bracket, so that that person could then sell the stock for a lower tax bill.
However, there are variables to consider here, said Tim Steffen, director of advanced planning in Robert W. Baird & Co.’s private wealth management group. For instance, a client may have incurred losses elsewhere in the portfolio that could cancel out the stock’s unrealized capital gains. Further, since a stock sale counts toward overall taxable income, a gift recipient may inadvertently get nudged into a higher capital gains tax bracket — thereby nullifying the initial tax arbitrage.
The kiddie tax could also be a deterrent, said Jeffrey Levine, CEO and director of financial planning at Blueprint Wealth Alliance.
The kiddie tax is a levy on a child’s net unearned income, which primarily constitutes income from investment assets. The first $1,050 of unearned income is tax-free, the next $1,050 is taxed at the child’s income tax rate, and anything in excess is taxed at trust tax rates (which hit their top rates after reaching just $12,750 of income). That scenario would most likely lead the child to pay “materially more tax” than the original owner would have under capital gains rates, Mr. Levine said. The tax applies to children up to 24 years old.
WHEN TO GIFT
Generally, though, advisers don’t recommend gifting highly appreciated stock, especially if the owner is close to death. An elderly client may be better off holding the stock until death, because it would then get a “step up” in cost basis. This resets the cost basis to the stock’s price at the time of death — meaning a beneficiary can then sell it for no capital gains tax.
“If you have some other resources that aren’t appreciated, you’d rather give that,” said Richard Behrendt, an estate planning attorney. “You’re benefiting them more.”
Conversely, it’s often better to give away stock that’s fallen in value during one’s life, Mr. Levine said, due to “double basis rules” that apply to gifted assets. The rules help from a capital gains perspective. Let’s say a client buys a stock for $10 a share, and gifts the stock to a nonspouse after it falls to $4. If the recipient sells that stock after it falls further, to $2 a share, there would be a $2 loss; however, if it appreciates to $12 a share, the recipient only has to pay capital gains tax relative to the original owner’s $10 cost basis (rather than the $4 inherited value).
Clients also may gift appreciated stock to charity, thereby avoiding capital gains tax and getting a charitable deduction (for those who itemize on their tax returns).
For the super-wealthy, gifting stock offers a way to get assets out of one’s estate to avoid estate tax at death. Estate values exceeding $11.4 million for individuals ($22.8 million for married couples) are subject to a 40% federal tax, and potentially an additional state estate tax, depending on the state.
This especially makes sense for those who own stock they believe will significantly appreciate in value, such as stock in a start-up, advisers said. Gifting the stock away during life gets any future appreciation out of the estate.