Not All Gifts & Inheritances are created equal!:Submitted by M.K. Byrne & Co. on August 17th, 2017
August 2017 - Not All Gifts & Inheritances are created equal!: Be careful when gifting assets during your lifetime or passing assets at death to ensure that the correct “tax beneficiary” is receiving the correct asset at the correct time. It might seem like an inconsequential decision to gift a child your only asset, $500,000 of Stock that you purchased for $50,000 rather than waiting to transfer that asset at death. However, by gifting that asset during your life, you have lost the potential for the family to avoid $450,000 in long term capital gains which your child must now eventually pay. Had the asset passed to your child upon your death – no income or estate tax would be due on any portion of the $500,000.
Another example of a seemingly immaterial decision resulting in costly tax consequences occurs when disposing of assets that are taxed differently in the hands of different beneficiaries. For instance, a $1 million Traditional IRA and $1 million in low tax-basis stock (i.e. Stock worth $1 million purchased for $100,000) have the same “value” for estate tax purposes - $1 million. However, in the hands of an adult child the $1 million in low basis stock is far more valuable than the Traditional IRA as all future distributions from the IRA are taxable to the child at his/her ordinary income tax rate. In other words, for your child, the Stock received is actually worth $1 million, but the $1 million IRA received is only hypothetically worth $600,000 after taxes are paid ($1 million in “value” less $400,000 in income taxes due). On the other hand, both the Stock and the IRA are worth exactly the same $1 million to the charity as it is a non-taxable entity. Therefore, proper tax planning would entail the transfer of the IRA to charity and the transfer of the stock to your child.
Finally, it may also be important to pass certain assets to certain specific beneficiaries that have most favorable tax situation for a specific asset. For example, a taxpayer may have two children, one of whom is financially successful and the other who struggles financially. This taxpayer would be wise to ensure that an asset with “poor tax attributes” like a Traditional IRA pass to the lower income child who will withdraw IRA money at a much lower rate of taxation than the higher income child. The higher income child may be better off receiving the stock from the scenario above.