Transferring stock to your kids can carry a range of different costs for you or your children. The Internal Revenue Service may impose gift taxes on large transfers and could tax you if you sell the stock to transfer cash. Once your kids own stock, their income from it may be taxed under special "kiddie tax" provisions. Furthermore, the stock that they own could end up hurting them -- or you, if you pay the bill -- when it comes time to apply for financial aid. How much transferring stock to your kids will cost you isn't always clear, but it's a relatively safe bet that it won't be "nothing."
As long as you give your children stock valued at less than the IRS annual gift tax exclusion, you shouldn't have to worry about gift taxes. For the 2013 and 2014 tax years, the exclusion is $14,000, which means you can give each child up to $14,000 of stock tax free. Your spouse can do the same. If you give more than the annual gift tax exclusion, you will have to file a gift tax return and either pay gift tax on it or use a portion of your lifetime exclusion, which is $5.25 million for the 2013 tax year or $5.34 million for the 2014 tax year.
Capital Gains Taxes
If you transfer shares to your kids, they typically inherit them at your cost basis or their value at the time of the gift if they're being transferred at a loss and with your acquisition date. For example, if you transfer 100 shares of stock on a day that they sell for $5,000, the gift would be $5,000. However, if you paid $25 per share for the stock and your child later sells it for $55 per share, his taxable profit would be the $30 difference between your cost and his selling price, not the $5 difference between the gift's value and its selling price. One possible consolation is that if you had held the stock for two years before gifting it and your son sold it one month later, it would be treated as a long-term gain, as he gets credit for the time that you held the stock to go along with his increased tax liability.
Once you transfer stocks to your kids, they become subject to the IRS' "kiddie tax." In an attempt to prevent high-income parents from transferring investments into their children's names to benefit from a child's typically lower tax rate and standard deduction, the IRS changes the rules for investment income earned by a minor. Instead of being able to claim the full standard deduction -- $6,200 for the 2014 tax year -- minors can only exclude their first $1,000 of investment income from tax. For 2014, the next $1,000 of investment income over that threshold gets taxed at the child's income tax rate, and anything over $2,000 in income, including capital gains, gets taxed at your tax rate, which is typically higher.
Financial Aid Implications
If your goal is to gift money to your child to help pay for college, it could backfire. If your child has any chance of being eligible for financial aid, the formula that many schools use penalizes students for having their own money. For example, under one formula, the college will assume that the student can contribute up to 20 percent of her assets to pay for her school expenses but assume that you can spend anywhere from 2.6 to 5.6 percent of your assets. In other words, if you gift your child $20,000 worth of stock, she'll have to contribute $4,000 of it. If you keep it, you would have to contribute between $520 and $1,120 of it. One way around this could be to gift the money to your child inside a college savings account or plan that remains your asset instead of hers.
Deciding What to Transfer
The decision to transfer stock to your kids is a personal one. While the IRS sets out its own rules for how the transfers will be treated from a tax perspective, you can also decide what you want to do in the light of your personal financial goals. On the one hand, while transferring stocks while you are alive might not always be tax efficient, you might want to see your children enjoy the money while you are alive or you might want young children to have the benefit of seeing an investment account grow. Your financial adviser or accountant can help you judge what is the best choice for you and your family.
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