You've worked all your life to amass your retirement savings. And you'd like to share the wealth with the rest of your family, too! This week, Jeff helps you straighten out the best ways to cut taxes on financial gifts.
Dear Jeff: When my stock split a few months ago I transferred those stocks to my children. My question is, what is the cost basis of these stocks when they sell it? Is it what I paid for it or what the price was at the time of transfer?
Jeff Says: If only it were true. If only we were able to establish a new higher basis in our investments when we gifted them to our children. Much to my dismay, and probably yours too, it is only wishful thinking.
When your children receive the stocks from you, they also receive your basis. The effect of this basis transfer is that they will realize the same amount of gain if they sell the stock as you would have realized if you kept the stock and sold it yourself.
Gifting stock or other property to your children has its advantages. The gifted property is removed from the donor's estate and can be enjoyed by its recipients. Unfortunately, if the primary motivation is to reduce or eliminate the capital gains tax that you will incur upon the sale of the property, then you could consider alternatives--including gifting to a charitable trust--about which I talk in more detail in a previous article.
There is one time when property can be left to our children and they will receive a stepped up basis, but it is not one particularly favorable to the donor. At death, property is received by our beneficiaries with a new basis, which is determined on the date of our death. Alternatively, therefore, it might make sense to retain the highly appreciated property until death and gift cash or other non-appreciated assets to your children.
Dear Jeff: How can I get info about a bypass trust? From my understanding, my wife and I would instruct, through our wills, that the first to die would pass $675,000 to the survivor, tax free. Then, when the surviving spouse dies, our heirs would get $1,350,000 tax free. They would only pay taxes on anything over that. If this is true, it sounds like it would be better than a living trust, which we just do not want to do. Please advise.
Regards, Lou and Sue
Jeff Says: It is very important when talking about trusts to make sure that we are actually talking about the same kind of trust, because each works differently and could serve a different purpose.
In general terms, trusts created during our lifetime are considered to be inter vivos. If the trust does not come into being until death, then the trust is said to be testamentary. Trusts can also be revocable or irrevocable. Revocable living trusts have received a lot of attention in the last several years for their benefits, which include avoiding probate, ease of administration during lifetime, continuation of management of assets in the event of incapacity, and privacy. However, revocable living trusts do not necessarily save estate taxes.
A bypass trust, on the other hand, is an estate-tax savings vehicle. It is usually a testamentary trust and becomes irrevocable upon the death of the testator (the person who created the will).
The purpose of the trust is to receive the largest amount that we are allowed to leave at our death to someone other than a spouse or charity without incurring any federal estate taxes. In 2002, this amount (the exemption equivalent) is $1,000,000, but the 2001 tax law change gradually increases this amount over the next few years.
Although we could leave the exemption equivalent amount to our children directly, our surviving spouses would not then have use of the money. Instead, if the bypass trust receives this amount, the trust document can direct the trustee to distribute principal and income for the benefit of our surviving spouse. Upon that spouse's death, the balance of the trust can be distributed to the children and will not be included in the surviving spouse's estate. The surviving spouse can also leave $1,000,000 at his or her death to children or other heirs without incurring federal estate taxes, which means that we have passed $2,000,000 without federal estate taxes.
It goes without saying that trusts, including bypass trusts, are more complicated than what you might have guessed from this article. I certainly recommend, as I usually do, that you consult with an estate planning professional if you think that you could benefit from a bypass trust.
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