Starting next year, new law might affect a gift of stock

December 02, 2007|By Carolyn Bigda | Carolyn Bigda,Tribune Media Services

Timing can play a crucial role with holiday gifts: You typically have a certain number of days to return that less-than-becoming scarf; a year or so to redeem a gift card.

This season, you also will want to pay extra close attention to when you cash in a gift of stock.

Parents, grandparents and other relatives frequently "gift," or transfer, a stock to a younger family member. It's a nice gesture and a way to cut taxes by taking advantage of a young person's presumably lower tax rate.

Starting next year, however, a new law could affect that strategy, leaving the recipient with a higher tax bill. Here's what you need to know:

The old rules

To prevent wealthy investors from shifting too many of their assets to young relatives, the government has long exercised the so-called kiddie tax. As it stands this year, if you're 17 or younger, you don't owe tax on the first $850 of unearned income (interest, dividends and capital gains) in 2007. The next $850 is taxed at a rate based on your income.

Once you've banked more than $1,700, however, you are taxed at your parents' rate.

The difference can be significant. Investors with low incomes pay 5 percent on long-term capital gains, or the profit made after selling a stock held more than a year. (Stocks owned for a year or less are taxed at the personal income tax rate.) Higher earners pay 15 percent.

The new rules

Under the old rules, once you turned 18, the kiddie tax went away. But starting Jan. 1, the cap is being raised to include 18-year-olds. Also, dependents ages 19 to 23 who are full-time students also are caught.

The new age limits are particularly biting because the capital gains rate is set to go to zero for those who would otherwise qualify for the 5 percent rate. From 2008 to 2010, those investors will owe nothing on their capital gains. (In 2011, the tax is reinstated, this time at 10 percent for low earners.)

What to do So what are you to do if your age works against you?

First, keep this in mind: You didn't have to own the stock. So even if you owe higher taxes when you cash in your shares, your wealth is still greater than it was before receiving the gift.

"You went from having nothing to suddenly having this asset," said Stuart Ritter, a financial planner for T. Rowe Price.

Second, Ritter advises against letting "tax consequences overwhelm sound financial principles."

"No more than 5 to 10 percent of your portfolio should be in a single security," he said. "Diversification takes priority."

That said, you want to minimize the tax bill as much as possible, especially because it is calculated based on the difference between the stock's current value and the price paid when bought, often referred to as the cost basis.

So, once you've received the stock, and thanked your parent, grandparent or whoever gave you the gift, the first thing you should do is ask when the stock was bought and at what price.

Normally, when a stock is purchased, an investor receives confirmation of these details. Ask your benefactor for this confirmation page.

With this information, you can make a decision about when to sell -- and not pay any more tax to the IRS than necessary. (If you don't know the cost basis, the IRS assumes the price was zero, meaning you owe tax on the stock's full market value.)

If you don't need to diversify or use the money for, say, next semester's tuition, calculate whether it would be smarter for you to sell before the New Year or wait until, say, you age out of the kiddie tax.

Either way, make sure the decisions mesh with your goals.

yourmoney@tribune.com

Carolyn Bigda writes for Tribune Media Services.

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