You Have a Quick Question (Why I Don’t Have a Quick Answer)

Anyone who prepares taxes has answered many calls that begin with the dreaded “I have a quick question”. Dreaded because 90% of the time there isn’t a quick answer, or at least one that is accurate according to your personal situation.

Taxes are complex, with many rules that only apply in certain situations, or that interact with other rules in ways that aren’t initially obvious. Most questions require a thorough knowledge of your personal situation, evaluation of your recent tax returns, and a discussion about your goals and future plans. To give an accurate answer, most accountants need more information and time to evaluate the situation. Giving you a quick answer may not be accurate or helpful in the long run.

Take this example:

Quick Question: What is the tax rate on stocks?

Quick answer: either your normal income tax rate or between 0-20%.

Better answer: It depends. While the rates are readily available on the internet, the tax rate on stocks isn’t usually the question being asked. You want to know what the tax rate will be on your stocks based on your circumstances.

To answer that, your accountant may need more information such as:

  • How long have you owned the stocks?
  • How much did the stocks cost?
  • How much do you believe you will be selling them for?
  • Did you inherit the stocks?
  • Were these stocks part of an ESPP/RSU/ISO?
  • What other income sources do you have?
  • How much do you project your income to be including wages, interest, dividends, business income, passive income, retirement, etc?
  • Do you expect to itemize? If so, how much do you expect the deduction to be (medical expenses, state taxes, personal property taxes, property taxes, mortgage interest, charitable giving)?
  • Any other big changes in your life this year?

After asking these questions, and perhaps others, I can tell you the tax rate on your stocks will be x%.

But knowing the tax rate doesn’t give you a full picture of how the sale of the stocks will affect your overall tax situation.

Depending upon your overall income, you may also have the pleasure of paying the Net Investment Income Tax; an additional 3.8% on your investment income. I call it the “Congratulations! You earned money on your investments and now you get to pay more tax” tax.

  • Income or losses on stocks may also affect:
  • the income tax bracket you’re in for your regular income
  • how much of your Social Security income is taxable
  • the amount you can contribute to an IRA
  • education credits
  • credits related to dependents
  • how much you pay for an ACA healthcare policy

Summary: Asking your tax professional for a quick answer is in many ways like calling your doctor, telling him your stomach hurts, and expecting him to diagnose and treat it immediately over the phone. Most of the time you’re not going to get the results you want. The doctor will likely need to ask additional questions, examine you, and maybe run some tests in order to treat you.

The same is true for taxes. In order to get the results you want, your tax professional will often need information and time to fully address your question.

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Sharing the Wealth Without Paying Gift Taxes

As the holidays grow close, the challenges of 2020 may have led you to consider giving gifts of money or assets to loved ones. Maybe you want to give cash to help with bills or a down payment on a house, or you’d like to transfer ownership of a house to someone.
If so, there may be no better time than now. The temporary increases in the Lifetime Estate and Gift Tax Exemption provided by the Tax Cuts and Jobs Act (TCJA) can help you potentially lower the taxes owed by your estate.

Gift Tax

The Gift Tax is a federal tax that the Internal Revenue Service (IRS) imposes on transfers of money or property while getting nothing (or less than full value) in return. The rates range from 18-40% and are usually paid by the giver. The point of the gift tax is to prevent people from avoiding the federal estate tax by giving all of their assets away before they die.

Annual Gift Tax Exclusion

The Annual Gift Tax Exclusion allows you to give anyone up to a specified amount of money each year without affecting your taxes. For 2020 the limit is $15,000 per recipient. The recipient could be your son, great aunt, dog walker, Lyft driver, anyone. If you’re married, your spouse can give $15,000 to anyone as well. Gifts between spouses are excluded from gift and estate taxes.
The purpose of the Exclusion is to prevent taxpayers from having to report every gift given during the year, such as giving their grandchild a gift worth $100 for their birthday, or giving their daughter $2,000 to put towards her honeymoon. For once common sense ruled the day and the Exclusion was created to avoid time-consuming paperwork that benefitted no one. As long as you give each person $15,000 or less, there is nothing else you need to do.

Lifetime Estate and Gift Tax Exemption

The Lifetime Estate and Gift Tax Exemption, on the other hand, allows you to give a large amount during your lifetime and through your estate without paying gift taxes on it. Before TCJA was passed in 2017 that exemption was $5 million. TCJA temporarily changed that amount to $10 million plus adjustments for inflation. For 2020 the exemption is $11.58 million. If you are married, your spouse can use the full exemption as well.
As an example, let’s say that you have decided to pay for your grandchild’s college education, and the first year will cost $100,000.

Gift $100,000
Annual Exclusion – 15,000
Gift after Exclusion $ 85,000

If the Lifetime Exemption didn’t exist, you’d have to pay gift tax on $85,000. Let’s take it further and include the Exemption:

Lifetime Exemption $11,580,000
Gift after Exclusion – 85,000
Remaining Exemption $11,495,000

By taking the remaining $85,000 out of the Lifetime Exemption, no tax will need to be paid on the gift.

How Does this Help with Taxes?

If you have substantial assets, gifting the assets now allows you to transfer it at its current value, keeping any appreciation between now and your death out of the estate. For instance, if you transfer ownership of your vacation home to your son now, and it’s currently valued at $500,000, the amount deducted from your Lifetime Exemption would be $485,000 after the Exclusion. But if you kept it, and it was worth $1 million when you died, the entire amount would be deducted from your Exclusion as it passed through your estate.

But what if you don’t have over $11 million in assets that you’re looking to give away? How does this benefit you? Let’s say you want to give someone $150,000 to help with a down payment on a house. Without the exemption you would have to give them $15,000 for 10 years ($30,000 for 5 years if you’re married) to avoid paying gift taxes. With the exemption, you can give it to them all at once.

Why is Now a Good Time?

The exemption increases provided for in the TCJA are not permanent, it is set to expire in 2025 and will decrease to around $6 million beginning January 1, 2026. That timeframe is not guaranteed, Congress can change tax laws at any time, and there are no assurances that there won’t be changes before 2025.
On the bright side, if you were to give $11.58 million now and then the limit is reduced, the IRS has decided that there will be no clawback of gifts; they won’t retroactively charge tax on the excess. If the lifetime limit is decreased after you give the gift, the additional amount you gave will not be subject to estate taxes in the future.

How Do I Take Advantage of This?

The simplest method of using the exemption is to give an outright gift, provided you are willing to give up all control of the asset. Once it is given, you have no legal say in what the recipient does with it.
Another option is to put the asset in a trust, which can offer the giver more control over how the asset is used. A trust may be beneficial to those who are reluctant to give sizeable gifts due to the potential need for assets in the future. There are several types of trusts, and many ways to structure management and distribution of the assets in the trust. If you are considering establishing a trust, consult with an estate attorney and a CPA or Enrolled Agent with experience in trusts and estates.

The Bottom Line

The current tax laws offer a rare opportunity to gift a substantial amount while avoiding paying gift/estate taxes. Because it is a limited time offer, it may make sense to gift the assets now rather than wait for them to pass to your estate.

The issues surrounding gifts are complex. Every tax situation is unique, and what works for one person may not for another. Before you make any irrevocable decisions, consult with a tax and estate professional to determine what is the best course of action for you.

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