Baby P wrote:

Dong, how do you feel about gifting shares of stock to family? I hear it’s one
oft-used tax-shelter for those in the know.

BP

I’m a big fan of gifting shares in general, but I’m not sure if I’m in the know.  Gifting shares are not the big tax shelter some might think it to be.  Not that there are defininite tax advantages to gifting shares, but it you do if it’s all on the up and up (as it should be) it’s not a gigantic loophole to be exploited

When it comes to gifts, the first thing is understanding the annual exemption, and lifetime estate exemption. Everyone is allowed to give anyone else $12,000 (up form 10,000) free of of any special filings. After $12,000 you need to make gift tax filing, then it starts counting against estate tax exclusion. Taxes still don’t need to paid until the total gifts exceed the exclusion amount (which is $1,000,000).  [Correction, originally stated ast $2,000,000 and shifting - that’s the Estate Tax exemption] There’s often confusion about whom the gift tax applies to.  It’s owed by the person making the the gift, not the receiver of the gift. So if for example you were to give your sister, $11,000 of MSFT that you purchased for $5,000, you would be under the exemption amount. No taxes would be due. Anything over 12,000 would then start chipping away at your estate exclusion. For this reason, it’s often advisable to start giving often and early but under the annual amount.

However your sister’s cost basis would still be $5,000, and if she were to sell the shares would have to pay taxes on the gain of $6,000. She also keeps your holding period. The clock on long term gains does not reset. Assuming that you and your sister were in the same tax bracket, no advantage would be had. However if she is in a lower tax bracket then in net the tow of you would save on taxes. Another thing to note is that you cannot apply the same logic to depreciated property. In the example above, let’s say the shares of MSFT were purchased for $11,000 and now are worth only $5,000. You can’t use a gift to transfer a tax loss to your sister. She wouldn’t be able to sell the shares of MSFT for $5,000 and claim a $6,000 loss. Her basis would be the lower of the value at the time of gift or the original basis if she’s selling for loss. If she sold between $5,000 (the value at gifting) and the $11,000 (the original basis), there would be no gain for tax purposes. At any value greater than $11,000 and she would have a taxable gain based on the original basis, $11,000. If gift taxes are paid then those taxes can be used to reduce the cost basis.

Inheritances are treated differently. An inheritance has something called “step-up” basis. The basis is set at the the time of death. For example if you were to inherit a house that is worth $1,000,000 but was purchased many years agos for $10,000, your basis is $1,000,000 rather than $10,000. This clearly makes a huge difference. Gifts and inheritances are highly related. As a result people who have “alot” really do need to have a carefully crafted plan of action to minimize both taxes and other complications for their loved ones. Gift taxes are also more complicated than I’ve laid out here. There are number of exemptions such as the unlimited exemption between a married couple. Gifts made directly to pay for medical and educational services are also exempt, the Kiddie Tax, etc.

Disclaimer:  I’m not a financial professional.  This is merely answer based on what little I know and should not be construed as financial advice.   It’s commentary more than anything else.

Corrections: The gift tax exemption is $1,000,000 not $2,000,000 as originally stated.  Thanks to savingforwealth for the correction.  I assumed that gift tax exemption would follow the estate tax exemption as they are closely linked.  I thought wrong.