Q:

Subject: Question on College Gifts

 

Kerry;

 

Our daughter is graduating from high school this June. Her grandparents want to gift her stock and cash to help pay for college. I am not sure of the amounts but was wondering if I need to consider tax ramifications. Is there a certain amount we  should try to stay with in each year?

 

Thank-you;

 A:

The issue of gifting has several facets to it, many of which your parents should discuss with their personal tax advisor.  The following should help them in their game plan.

First, from the perspective of you and your daughter, the receipt of gifts is one of the few things that is entirely exempt from income tax.  There is a potential gift tax that would be levied on the givers, which I will discuss below.

Next is the issue of cost basis of the gifts for your daughter.  With cash gifts, the issue of basis is moot.  It is just what is received.  However, for non-monetary assets, such as stocks, it gets trickier.  For gift tax purposes, their fair market values at the time of the gift are used.  For publicly traded stocks, that is just the current market price. 

For the cost basis to the recipient, she must use the lower of the giver's cost basis or its fair market value.  This is normally a serious issue with highly appreciated assets because it means that the givers (aka donors) are also transferring the potential capital gains tax obligations to the recipient. As an example, suppose your parents paid  $10 per share for a stock that is now worth $100 per share.  For gift tax reporting, the $100 per share value is used.  However, for your daughter, her cost basis in the stock remains at just $10 per share.  This won't trigger any taxes until she sells the stock, at which time her gain will be the excess over $10.  So, if she were to sell the stock shortly after receiving it, she would have a long term capital gain of $90 per share to report on her income tax return.  Her holding period does include that of the previous owner.  This isn't necessarily a bad thing overall and is often done intentionally if the recipients are in a lower tax bracket than the givers were or have other capital losses that can offset the gains.

If the asset has gone down in value from the giver's cost basis, a gift is generally not a smart move, tax-wise.  Suppose the numbers in the above example were reversed.  Your parents paid $100 per share for stock that is now only worth $10 per share.  While the gift tax would be based on the $10 per share value, so would the cost basis for your daughter.  This effectively eliminates the opportunity for anyone to deduct the $90 per share capital loss.  In cases like this, it would be better for your parents to sell the stock and claim the $90 per share capital loss on their tax return and just give the cash to your daughter.


Now from the perspective of your parents, the givers, and their gift tax requirements.

There is an annual tax free allowance that many people use in order to time their gifting and avoid the need to file any gift tax returns.  It is currently at $11,000 per donor per donee per year.  That means your mother could give your daughter $11,000 and your father could also give her $11,000, for a combined total of $22,000.  As I mentioned above, the values are the fair market values of the assets.

If they give more than the annual tax free allowance, they will have to file a gift tax return (Form 709) to report the gifts to IRS.  Because these would be gifts from grandparents to a grandchild, they would be possibly subject to the 47% Generation Skipping Transfer (GST) Tax, rather than the normal Gift Tax.  They have the option of either paying the tax or using part of their lifetime exclusion, which is now $1.5 million per person.  That's $3 million combined for your mother and father.  On their 709s over the years, they are required to keep a running tally of how much of that lifetime exclusion they have used.  This actually carries over to their estate tax returns (Form 706) to see how much of their lifetime exclusion is still available to be used against that tax.

Now for a little fact that might help you all to decide how to structure things.  The above discussion dealt with transfers from your parents to your daughter.  There are a few types of transfers that are not required to be even counted when considering gift or GST taxes.  Those are direct payments for medical costs and for tuition.  So, if your parents were to pay your daughter's tuition directly to the college, no reporting to IRS is needed.  If, however, they give money directly to your daughter and she uses it to pay for her tuition and other school costs, there could be gift tax reporting requirements if the total paid during a calendar year exceeds the $11,000 per donor/giver threshold. 

What would probably work out best is for your parents to pay the college directly for the tuition and then gift your daughter other money to cover her books, supplies and dormitory fees, which are not covered by the special exemption.  Of course, they should work out their strategy with their own tax advisor.

This is probably a longer and possibly more confusing answer than you expected.  However, who can make the claim that tax matters are simple in this country? Let me know if you need to discuss any of these points in more detail.

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 5/19/2005 03:06:00 PM Send this post: