Consider Shifting Investment Income

TAX ADVICE from Julian Block

(January 27, 2005) The 2003 tax act reduced tax rates for investors with long-term capital gains from sales of stocks and most other assets owned more than 12 months. The act lowered the top rate from 20 percent to 15 percent for individuals in the four highest income-tax brackets of 25, 28, 33 and 35 percent. Their top rate for dividends also dropped to 15 percent. Both reductions apply through 2008.

The top rate for long-term gains and dividends became 5 percent for those in the two lowest brackets of 10 percent and 15 percent, a reduction that applies through 2007 and drops from 5 percent to zero percent for 2008.

What happens after 2008? For now, wait and see.

Meanwhile, rates as low as 5 percent for capital gains and dividends, at least through 2008, open up a smorgasbord of tax-saving maneuvers for investors in 25-percent-or-higher brackets. Wannabe benefactors, whether parents, grandparents or others, should think about shifting investment income from themselves to lower-bracket individuals, such as children, grandchildren and others, by making gifts to them of assets that have gone up in value over the years.

Substantial transfers of stocks and other kinds of income-producing property are usually more advantageous when the gifts go to individuals who are at least 14 years old and in the lowest brackets of 10 percent and 15 percent. The significance of age14 is that the law exempts persons who have attained that age from the so-called kiddie tax rules.

These rules generally tax under-age-14 children at their parents’ top rate for “unearned” income, meaning investment income from interest, dividends and the like that surpasses a specified amount that is adjusted annually for any inflation. For tax year 2005, the magic number is $1,600. Above-$1,600 income gets nicked for taxes at the parents’ rate.

The $1,600 breaks down as follows: The first $800 is sheltered from taxes by the child’s standard deduction for unearned income. The next $800 is taxed at the child’s rate. Only income above $1,600 is taxed at the parents’rate. When a child’s income comes solely from long-term gains and dividends taxed at 5 percent and aggregates less than $1,600, the tax goes no higher than $40 -- $800 times 5 percent.

A child who has attained age 14 could have income well above $1,600 from capital gains and dividends and still be taxed at 5 percent, not 10 percent. Using 2005 as a marker, not until taxable income surpasses $29,700 does a single person move beyond the 15-percent bracket and ascend to the 25-percent bracket; the brackets are indexed, same as the standard deduction amounts.

Another benefit of property transfers: They reduce the value of assets subject to potential estate taxes upon death. But as part of their planning, donors need to consider gift taxes when they make sizable life-time transfers of assets. Or instead of life-time gifts, should the assets pass through their estates to their heirs? Bequeathed property gets stepped up in basis from its original cost to its date-of death value, meaning the heirs are subject to capital-gains taxes only on post-death appreciation.

Legislation enacted in 2001 partially repealed the step-up in basis. But that change does not take effect until after 2010 and applies only to individuals who die in 2011 or later and leave large estates. And that change might be further revised or even undone between now and 2011. For advice on your particular situation, you might need to huddle with a qualified tax professional.

Julian Block lives in Larchmont and is a syndicated columnist, attorney and former IRS investigator who the New York Times has called “a leading tax professional.”

His “Year Round Tax Savings” shows how to save big money on taxes – legally. To purchase a copy, email: at


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