Let's talk cost basis and capital gains tax.
What if you are the owner of two blue-chip stocks worth $100,000 and have owned these for more than 30 years, paying taxes on the dividends every year? Rather than get hit with a capital gains tax, is it a good idea to gift the stock to your grandchildren?
What are the ramifications for taxes and/or cost basis if you gift these to the grandkids by changing ownership? If the grandfather does this while he is still alive, how does this shake out as far as taxes and cost basis for the recipients—or should he pass the stocks upon his death?
A recent New Jersey 101.5 article, "Tax differences between gifted or inherited stock," explains that there are several options—all with some ramifications; however, some may be more attractive than others.
Before examining the choices, first let's review cost basis and the capital gains tax. The cost basis is the price that you paid to purchase the stock in addition to other costs like commissions and fees. When the stock is sold, tax liability is calculated based on the cost basis and the sales price. If the stock is sold for more than the original cost basis, the difference will be taxable as a capital gain in the year of the sale.
If the stock is in a qualified savings account (an IRA, 401(k), or 529 plan), it would be taxed only when withdrawn.
If a stock is held for more than one year, it's considered to be long-term. These are taxed at lower rates than ordinary income. Long-term capital gains are taxed based on the taxpayer's tax bracket.
If the grandfather gifts the shares to the grandchildren, the ownership of the shares would be based on the age of the grandchildren. If they are minors, the shares would have to be held in custodial form, but if they are adults, they can own the shares in their own names.
Gifting shares while the grandfather is still alive will not get rid of the capital gains when the stock is sold.
The grandkids getting the appreciated stock would assume the same cost basis as the giver. In this instance, when the grandchildren sold the stock, they would have a capital gain. And if they're under 19 or full-time students under age 24, some of the tax rate on the sale of the stock may be taxed at their parent's tax rate. This is called the "kiddie tax."
The kiddie tax rules are pretty complex, but as a general rule, children under 19 or full-time students under 24 can exclude the first $1,050 of unearned taxable income from their tax return. The next $1,050 is taxed at the child's rate. Anything more than that amount is taxed at the parent's tax rate.
So, depending on the specifics, there may be little or no tax savings to be gained by giving the stock to the grandkids, and a higher tax rate might be paid if the kids' parents are in a higher tax bracket than the grandfather.
As another option, if the stock is gifted upon the grandfather's death, the grandchildren would receive the stock with a cost basis equal to the value at the date of death or—if elected by the executor—the value nine months later (this is called the "alternate valuation date"). This is a stepped-up basis. As a result, most or all of the gain in the stock immediately prior to the grandfather's death would be eliminated.
Reference: New Jersey 101.5 (March 3, 2016) "Tax differences between gifted or inherited stock"
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