Wealth Management & Financial Planning

Wealth Management & Financial Planning

Be Informed to Avoid Unnecessary Taxes

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A long-held, unfortunate and inaccurate perception is that the U.S has two tax codes – one for the rich and one for the poor. Actually, the two U.S. tax codes apply to the informed and the uninformed. We regularly see mistakes – or at the very least missed opportunities – simply because taxes were overlooked in the decision process and appropriate actions were not taken given the circumstances.

We recently helped a generous grandfather who wanted to pay his granddaughter’s college tuition. What a wonderful blessing! The grandfather had the best of intentions, his CPA answered the questions using the data he had available, and the parent (father of the daughter) conducted research on Google related to gifting tuition.

The CPA told the grandfather he could indeed pay the tuition and was naturally correct – schools don’t care who writes the check. The son discovered that the grandfather could give up to $14,000 to the granddaughter which was partially correct. What was missed in the analysis was how investing, taxation and desired results collide.

The grandfather is indeed limited to making a gift of $14,000 to anyone – blood relation or not – provided it is a gift of present interest. In other words, the recipient can use the gifted money for any reason. However, there are important exceptions that affected the grandfather’s gift! Checks sent directly to educational institutions or medical services are not limited by the $14,000 limit. The grandfather could have paid the entire $25,000 tuition to the university if he desired.

For years, the grandfather had held onto stock that didn't pay a dividend (thus not listed anywhere on a tax return) and there was a sizable capital gain from over two decades of appreciation. There is no way the CPA functioning as a tax professional independent from the financial planner would know about the existence of this stock. Should more questions have been asked? Perhaps, but that’s not the way most people think.

The grandfather wrote the $14,000 check to his son to pay for the daughter’s education as many people making the same gift would have. There's nothing wrong with that approach, but it is far from the most efficient use of the tax code.

The son is in the 15% marginal tax rate meaning that he will pay no taxes on long-term capital gains assuming the gain from a sale of stock will not push him to a higher bracket. The grandfather should have gifted the shares of the stock (up to $14,000 in value) and the son’s tax basis in the gift is the same as the fathers ($1,200 in this case.) The holding period – long term – also transfers. The son could sell the gifted stock, pay no taxes and then pay $14,000 of his daughter’s tuition.

While the approach described above sounds complex, it would have saved more than $2,000 in unnecessary taxation. Excess taxation due to being uninformed is simply unacceptable in a world where every dollar counts.

Tax advice provided by CPA’s affiliated with Financial Enhancement Group, LLC.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column offset=”vc_hidden-lg vc_hidden-md vc_hidden-sm”][vc_widget_sidebar sidebar_id=”sidebar-main”][/vc_column][/vc_row]

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