Questions: I bought some stock five years ago for $600 and gave it to my son recently after the value had grown to $10,000. Am I correct that I owe no capital gains tax on this profit? How will the tax be calculated if my son sells the stock?
Answer: By giving the shares away, you do, indeed, escape the gains tax on your $9,400 profit. Had you sold the shares, the 20 percent maximum capital gains tax would have been $1,880.
But Uncle Sam isn't dodged so easily. The government works hard to collect the capital gains tax a tax on profit. So, when your son sells the shares, he will owe capital gains tax.
This is an important issue at this time of year because many parents and grandparents are thinking about making substantial gifts of money, stock or other assets to reduce their estate taxes.
It might have been better, as you'll see below, if you had sold the stock and given your son cash.
In your son's case, the tax will be figured by subtracting your cost basis of $600 from your son's sale proceeds. If he sells for $10,000 he'll owe $1,880. If he holds the shares for a while and sells for $20,000, he'll owe $3,880, and so on.
But the rules aren't simple, and another case might be calculated differently. The cost basis, or original purchase price, used to figure any tax depends on whether the asset has gained value, or lost it, during the time the giver owned it.
If the value has gone up, the gift recipient's cost basis is the same as the giver's basis, as in your case.
But if its value has fallen by the gift date, one of three things can happen.
If the recipient eventually sells for more than the giver paid, a taxable gain is figured by subtracting the original cost from the sale proceeds.
Suppose the gift is sold for less than the value it had when it was received. Then a tax loss is figured by subtracting the sale proceeds from the value on the gift date. (In effect, this cheats you out of the additional loss you'd declare if the original cost were used in the calculation.)
But what if the asset is sold for more than the value at the gift date but less than the giver's basis? Then there is neither a gain nor a loss. (Again, the recipient misses out on some of the tax loss that the giver could have declared had the giver sold at the same price.)
All this should be weighed by people who are making gifts. In many cases, the giver is trying to reduce estate tax.
For people who die in 2000 and 2001, this is charged against portions of the estate that exceed $675,000, a level set to rise gradually to $1 million in 2006. The estate tax begins at about 37 percent and goes higher.
The law allows everyone to make tax-free gifts of up to $10,000 a year to each of an unlimited number of people. Many parents and grandparents use this rule to give away assets while they are alive to reduce the tax on their estates after they die. Recipients pay no income on these gifts but, as you see, can be subject to capital gains tax.
So, if one of your goals is to reduce your estate tax, next time consider selling the stock then giving $10,000 in cash. Thus, it would be you rather than the recipient who would owe the gains tax.
Paying the tax would further reduce your estate, and you could still give your son $10,000 a year tax-free. The gift really would be worth $10,000, rather than $8,120, since it wouldn't go to your son with that ticking time bomb your capital gains tax liability of $1,880.
Of course, I'm assuming you and your son are in income tax brackets of 28 percent or higher, so that each would be subject to the 20 percent capital gains tax. A taxpayer in the 15 percent income tax bracket pays a capital gains tax of only 10 percent. If just one of you is in the lower bracket, he should be the one to sell the stock.