How To Legally Avoid Taxes On Gifts And Inheritances – Part 2

Last week I explained in theory how you can legally avoid paying taxes on gifts and inheritances. Avoiding taxes on gifts and inheritances is based on cost-basis. To help you apply this to your situation, I want to share some real-life examples of how my clients use these principles to legally avoid paying taxes on gifts and inheritances. First, let’s briefly review cost-basis. When you receive an asset as a gift and sell it, you are responsible for paying capital gains tax. Capital gains tax is calculated using cost-basis. Cost-basis refers to how much money was invested in an asset. When an asset is sold, the cost-basis is subtracted from the amount received to determine the gain or loss. Your amount of gain or loss then determines how much you will pay in capital gains tax. In other words, you pay tax on the profit. Cost-basis becomes complicated when an appreciated asset is passed on to someone else, either through an outright gift or through an estate. If an asset is passed on before the giver’s death, then the recipient assumes the same cost-basis as the giver. If the asset is passed on after the giver’s death, the recipient’s cost-basis is the market value on the date used to calculate tax on the estate. This ‘stepped-up’ cost-basis can save tens of thousands of dollars in capital gains tax. A reader in St. Maries, Idaho was facing this very situation. A lady has owned some utility stock for decades, happily collecting the dividends. Now she’s getting older and wanted to give this stock to her son. Little did she know this would have resulted in thousands of dollars in unnecessary taxes! If she had given these shares to her son, he would have a large capital gains tax bill when he sold the shares. The way the IRS sees it, his ‘profit’ wasn’t the gain since he received the gift; his profit was based on how much his mother originally paid for the shares. I explained that if the son inherited that stock after mom’s death, they would legally avoid paying 15% in taxes on decades’ worth of gains. They quickly agreed! The situation is far different for an elderly client of mine. He lives on a farm that has been in his family for eight generations. He inherited the farm over the 70 years ago and, obviously, it has appreciated greatly. Since his estate will be over $1,500,000, his family could lose up to 50% to estate taxes. Imagine -- his daughters could be forced to sell the farm after 8 generations so the tax could be paid! In this situation, it is better to pay capital gains tax of 15% then estate taxes of 50%. Plus, there isn’t any tax on the gains until the farm is sold. Since his daughters plan on passing it on to their children, the taxes can continue to be deferred for decades. So he’s been carefully gifting the maximum amount he can to his daughters each year over the last ten years. We calculated that he will legally avoid $750,000 in estate taxes. Few of us have large farms, but most retirees own their home. And many times, the home is the most highly appreciated asset of the entire estate. Unfortunately, as they get older many parents make the mistake of putting their child’s name on the deed to their house. This is an especially common practice for widows. What people don’t realize is that when they put their child’s name on the deed to their home, the IRS considers that a gift. Therefore, the child has the same cost-basis as the parent. So when the child goes to sell the house later, he or she will face a hefty capital gains tax bill. If the value of the estate is less than $1,500,000, there wouldn’t be any tax on the profit of the house if it was passed through the estate at death. So think twice before gifting someone an appreciated asset. Remember that adding someone’s name to a bank or brokerage account is the same as a gift. With some simple planning you can legally avoid losing tens of thousands of dollars in taxes. I’ll personally answer your financial questions. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

How To Avoid Tax On Gifts And Inheritances

Nobody likes to pay taxes. If done incorrectly, though, the way you inherit an asset can result in you needlessly paying tens of thousands of dollars in taxes. Knowing some simple rules will reduce your tax bill and allow you to keep more of what you inherit. And it will also keep you from creating tax headaches for loved ones to whom you wish to gift assets. Whenever an asset is sold, Uncle Sam wants to collect capital gains tax. And that tax is figured using cost basis. Cost basis refers to how much money you invested in a given asset. When sold, the cost basis is subtracted from the amount received to determine the gain or loss. Your amount of gain or loss then determines how much you will pay in capital gains tax. If you buy an asset for $10,000 and sell it for $25,000, your cost basis is $10,000 and the taxable gain is $15,000. Currently, the highest capital gains tax rate is 15%, which means you’d owe capital gains tax of $2,250. Losses can be used to offset other gains, but we won’t get into that in this article. Determining the cost basis can get complicated. If you buy an asset and add money to it, your cost basis increases. If it’s a mutual fund and you have the dividends reinvested, that adds to your cost basis. If you sell a portion, that affects your cost basis as well. This means that it is important to keep track of the amounts you paid and received on all of your assets. An asset can be many things, not only stocks and bonds but also houses, property, jewelry, coins, artwork, etc. Legally, you are required to pay capital gains tax whenever an asset is sold at a profit. In fact, 1099’s are issued whenever investments like real estate, stocks, bonds, and mutual funds are sold. Here’s where people lose thousands of dollars. If someone gives you an asset, you ‘inherit’ the giver’s cost basis in that asset. So if mom gives you $10,000 of stock that she’s owned for years, you inherit her cost basis and are responsible for paying the capital gains tax on it when you sell it. If she only paid $1,000 for that stock and you sell it for $10,000 then you will owe taxes on the $9,000 gain. On the other hand, let’s say you inherited that stock from mom after her death (through her estate). Then your cost-basis would be the stock’s market value at that time. This is called ‘stepped-up basis’. So, even if mom only paid $1,000 for the stock, if it is valued at $10,000 when you inherit it you can sell it and not owe any capital gains tax. You just legally avoided the Tax Man! This stepped-up basis is the government’s way of making up for people having to pay taxes on the transfer of their wealth. But estate tax laws are in a state of flux. Under current regulation, the stepped-up basis disappears in 2011. However, there’s some talk in Congress of doing away with stepped-up basis altogether, especially since the death tax only affects estates that are larger than $1,500,000. Most likely, if Congress ends the estate tax for all but the largest estates, they will collect revenues from smaller estates by abolishing stepped-up basis. There are situations where it is better to have an asset given to you instead of it being inherited. It all depends on the size of the estate. Death taxes range from 37% to 50%, while capital gains tax rates are capped at 15%. So if an estate is going to be worth less than $1,500,000 then there will be less tax paid by inheriting an appreciated asset through the estate. If an estate will be worth more than $1,500,000 then less tax will be paid on that appreciated asset if gifted to you prior to death. I’ll provide several examples in my next article that will clearly illustrate real-life situations. That way, you will be able to more easily determine which course of action you should take and can save thousands of dollars in the process! There’s no reason to pay tax when you don’t have to! I’ll personally answer your financial questions. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Slaying the Ghosts of Markets Past

There are many investors who are “once bitten, twice shy” when it comes to investing, especially those that have had significant losses in the past. Unfortunately, those bad memories are causing many of them to make bad investment decisions today. Over-generalizing past experiences, both good and bad can have dire affects on your hard-earned nest egg. Many people who traditionally shunned stocks began investing in the stock market during the ‘90s. They were handsomely rewarded. But those investors (and their advisors) failed to realize the dramatic shift that began occurring in 2000. As a result, many lost much of what they had gained, some selling out with huge losses. It’s understandable that someone is hesitant to invest in an area where they’ve lost significant amounts in the past. One of the biggest mistakes investors make, though, is to overreact to investment experiences. You certainly want to learn from the past, but a knee-jerk reaction will create a host of new ones that will greatly impact you long-term. Stock markets naturally fluctuate, but these ‘bitten’ investors become very nervous with even minor market drops. The truth is that the markets don’t move up in a straight line. You can’t take your money out of the market every time it posts a small loss and reinvest later after it’s recovered—you’ll continue to lose money. Past experiences cause many investors to entirely shun a category that should play an important role in their portfolio. Many investors today want to avoid equities all together. Others might avoid real estate. You may have lost money in a bond mutual fund and now avoid all mutual funds. But avoiding any category completely is a big mistake. A properly balanced portfolio has been shown to contain less risk than an unbalanced one. Some REITs provide an excellent, stable source of income but some investors avoid them like the plague because they bear a slight resemblance to failed limited partnerships of the 80’s. They’ve allowed losses they suffered on LPs years or decades ago keep them from benefiting from quality REITs today. Just as bad experiences color our investment vision so do good experiences. This can cause investors to over-invest in a single category. Technology stocks are one example, bonds are another. For the last two decades, bonds have given returns approaching the high single digits, making them the investment of choice for retirees. Bond’s great returns have caused many retirees to over-invest in them. Most have seen the level of interest they receive plummet the last few years and have turned to risky investments to replace that lost income. This puts them in a precarious position moving forward. Successful investors have learned the secret of not overreacting and over-generalizing. They recognize that their bad experiences could have been the result of issues specific to an investment but didn’t affect the rest of the category. Perhaps the mutual fund they were in had bad management or used an ill-timed strategy. But that doesn’t make all mutual funds bad. They also realize that various investments will perform differently depending on the market and economic environment. The same investment can be the worst possible investment in some situations, but the investment of a lifetime in other situations. For instance, there is a mutual fund called Rydex Tempest that is designed to produce a return twice the opposite performance of the S&P 500. Funds like this are called ‘inverse funds’ because they move up when the index goes down and down when the index goes up. In 2003, Rydex Tempest dropped 43%! An investment of $100,000 in the beginning of that year would have been worth only $57,000. On the other hand, Tempest was up 37% in 2002—a terrible year for the market. Is this fund a good or bad investment? Neither. There’s just a right time and a wrong time to be invested in it. When it comes to investments like stocks, bonds, mutual funds, or real estate investment trusts, how and when the investment is used will in large part determine whether it was a good or bad investment. So don’t let the ghosts of markets past cloud your investment decisions today. Don’t overreact. Properly managed, each category of investments will play an important role in your portfolio. I’ll personally answer your financial questions. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Equity Indexed Annuities: Putting Lipstick On A Pig

Buyer’s remorse—we’ve all had it from one time to another. But when it comes to investing your life’s savings, the last thing you want is an investment that you will soon regret. Here are some secrets that can prevent that from happening. Staying out of the wrong investment in the first place is much easier than trying to get out of one later. Often, the problem is that you aren’t given all of the information, or it’s presented using terms that you aren’t familiar with. Either way, the deck is stacked against you. When you sit down with the typical commission-based advisor, their job is to sell you something. They’ve been well trained on how to present a product in the best possible light. They know how to handle your every objection. They have a number of closing techniques to persuade you to make an immediate buying decision. They don’t have to have a great product to offer in order to get you to invest. In industry lingo, sometimes advisors have to “put some lipstick on that pig.” Many times a product isn’t accurately portrayed. An investment’s blemishes can be well hidden by some clever salesmanship. Here’s a real life example. These are phrases pulled from a brochure for a well-known equity indexed annuity: ‘Get an immediate gain with a 10% premium bonus.’; ‘Your principal and bonus are never subject to market risk.’; ‘Protect your principal and bonus from market loss.’; ‘Lock in your index and/or interest gains and get your best year’s growth – guaranteed!’ Sounds like the perfect investment, doesn’t it? But when you take the time to drill down through the fine print in the actual annuity contract and decipher all the legalese, you quickly find it’s a pig-in-a-poke. Although this annuity is a ten year contract, if you take your money out 10 years later you don’t get ANY of the promised index gains! If you initially invested $100,000 you are guaranteed to only get $101,457 ten years later! That’s right. You will have made $1,457 after 10 years! In order to get any market gains, you must annuitize the contract over a 10-year period. If you don’t find out about that until the 10th year, you will have to leave your money invested for a 20-year period to get ANY index gains. Even then, you don’t get any of the index gains that occurred during the second 10-year period. It’s not sounding so good now, is it? It gets worse. If you ever need more than 5% of your money in a year, you have to pay a stiff surrender penalty to do so, up to 12.5%, plus you lose your bonus. So you can get back less than you invested even after 8 years! Even if you die before the contract is up and your heirs cash out, they are virtually guaranteed to get back less than you put in. And these are just a few of this investment’s blemishes. Even if the salesperson mentioned these disadvantages, it’s done in a way that makes them seem unimportant. Many people have purchased this pig without realizing what they were getting themselves into. Many won’t even know until they go to cash it in after 10-years. Since they see the index gains on their statement they believe all is well. I’ve used equity indexed annuities as an example, but the same story can be said about any number of investments. There are no perfect investments! Every investment has advantages and disadvantages. Don’t take what advisors tell you at face value. Do your homework. Research the product on the internet. If it’s an insurance product like an annuity, make sure you see and read the contract before you invest. If you don’t understand it, find someone who is unbiased to help you (not the person trying to sell it to you!). The insurance company will only do what is in the contract regardless of what the agent makes you think the contract says. Never give into pressure to buy right then. That’s just a sales tactic. Make sure you know how your investment works and how you can get at your money. Doing so may prevent making an investment you will live to regret. I’ll personally answer your financial questions. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.