Archive for the ‘Tax Planning’ Category

Gifting and Cost Basis

December 16th, 2010 Vijaianand

In the last post, we saw how tax plays a important role in gifting to charity or a family member. We saw the tax consequence like deductions and exclusion from donor’s perspective. After that post, I got a request to explain about cost basis in relation to gifting. At times we do recieve gifts or inherit properties from our family members so we need to look  at tax implications from donee’s perspective to declare gains or losses from those gifts. In order to report gain or loss from the gifts or inheritance, cost basis is an important factor needs to be considered.

What is Cost Basis?


Cost basis is the original cost paid for the property including any commission or fees involved to acquire the proeprty whether its tangible(home, equipments) or intangible (stocks, bonds). If a property is purchased, the cost basis is the cost associated with the property including all the expenses related to the purchase.   In this post we will see more about the cost basis involved with gifting or inheritance.

Why cost basis important?


When you inherit/get gifts of property, starting cost basis is set according to the acquired method. When those properties are sold, the selling price is usually different from the original purchase price. Either a capital gain or a capital loss is realized during this transaction which needs to be reported to the IRS by the taxpayer. In order to calculate the amount of capital gains and losses the cost basis of the stock must be determined.


It can be a short term or long term capital gain depends on the holding period of the property. For gifted property, holding period various depending up on the length property owned by donor and donee. If you are using stepped up basis for inheritance property, it is always long term holding period.

Cost basis – Gifted Property

If the property is received as a gift then the basis is various depending on the FMV of the gift at the date of gift  or original cost of the property bought by the donor.

The donee’s starting cost basis is the lesser of either:


cost basis of the person who gifted the property which is called carryover basis, or the market value of the stock on the date the gift which is called  stepped up basis. It depends on the property value at the time of gift and property sale value by the donee.

If the FMV of the property gifted is more than original cost, donee should use the cost basis of the donor. That means donee carry’s over the donor’s cost basis. On the other hand if the FMV of the property is less than original cost, then dual basis rule comes in to play depending on the sale price. That is, if the donee sells above donors cost basis, then donee takes donor basis and report gain. If the donee sells below of the donors cost basis, then donee takes the FMV as the cost basis. If the donee sales between FMV and donors cost basis, no gain or loss need to be reported. I know its bit confusing but look at the example below and it will be clear. 

Example

An example of basis in which a gift results in a gain would be as follows:


Anna gives Sara a  painting. Ronald paid $10,000 for the painting, and the fair market value (FMV) of the painting is $20,000 at the date of the gift. If Sara sells the painting for $20,000 she will use Anna’s cost basis of $10,000 is used to report the capital gain. Thats carryover basis.



However, the example above does not apply if Anna had gifted his painting to Sara when its FMV was $8,000, which is less than his original basis of $10,000. The capital gain or loss reported by Sara depends on whether she subsequently sells the stock for a gain or a loss.



Let’s look another example in which the same gift could result in a loss:



If Sara sold the painting for $15,000 then Sara would report a capital gain of $5,000 using Anna’s original basis of $10,000 to calculate her gain. However, if Sara sold the painting for $5,000 she would report a loss of $3,000 using the stock’s FMV basis of $8,000 to determine her loss. Note that if Sara sold the stock for $9,000 she would not report a gain or a loss in this situation.


Cost Basis – Inherited Property

If you inherit a property, the cost basis will depend on when you inherited it and who you inherited it from.  In general, if you inherit it before 1/1/2010, the cost basis is “stepped up” from the  original cost paid by the deceased owner to the fair market value on the date it was bequeathed to you. This is called a stepped-up basis. Stepped basis is when the donee(who recieves the stocks) gets the  FMV (fare market value) as their starting basis instead of donor’s original basis.

You can use the free calculator available at costbasis.com



Costbasis Reporting

You might have recently received an email or mail from your broker about Cost basis reporting. It was part of the “Bailout Bill” signed in 2008. This bill is $11 billion cost basis reporting.  Starting from 2011, every broker or agent should track the cost basis of the investments and report at the end of year to help the investors to easily track their cost basis and fill the taxes properly. For more details, you can check out the article at WSJ. It will surely save you time and money for the government.

source: www.costbasis.com

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Gift Giving Traditions & Tax Consequences

December 9th, 2010 Vijaianand

It is December, holiday time to remember and   special time to cherish with your friends and family. Its also considered the special season of giving. Compared to last year, the charitable giving is much better according to the recent reports. Even when the economy still under waters and trying to be afloat, it is amazing to hear that people are still trying to give and share their joy with the needy.   

I just heard from radio today that Facebook founder Mark Zukerberg has signed up Giving Pledge, a Billionaire charity giving initiate started by Microsoft founder Bill gates and Mr. Warrent Buffet. He took the pledge to give away majority of his assets to charities around globe during his lifetime. That’s really amazing thing to do.

You can ask, “why should I have to give?”


Giving is all about sharing yours with others to bring happiness around you. According to law of attraction, by giving you attract more of it.  Many religions encourages to do charity in a great way. They usually recommend to give away atleast 10% of your earnings to charities. Giving not only satisfy our inner soul but also helps to save and get some money in return as an appreciation from Uncle Sam. Tax incentives is an added bonus encouraging many to give. There different ways of giving. You can give/gift to your family members/friends, to charity and may be to your business related people. Every gift giving has different tax consequences.


Tax Consequences


Family/Relative Gifting

If you give to family members or friends, gift tax might apply beyond the annual exclusion limit. Also just about anything you give away could be subject to gift tax. But there are exceptions to it.



1. Give with your whole heart to your sweet heart, you are free from all taxes. Yes, No gift taxes for transfers to a husband or wife. But one catch, if you give a terminable interest property to your wife in which your wife’s interests ends in the future date, you will have to file a gift tax return.


2. Pay directly to schools/colleges or hospitals to cover the tuition cost for your grand kids or medical expenses for anyone.  No tax need to be paid. These are called qualified transfers.

3. You can give as gift to anyone upto $13000 without any taxes and not filing any gift tax return. The annual exclusion is $13,000 for tax years starting from 2009. You wish to give away of than $13000, you don’t have to pay taxes immediately but you will have to file gift tax return Form 709 and let the IRS know about it. IRS will apply to the unified tax credit and defer until you finish all your credit. If you are married you can file the split gifts with your wife and give away upto $26000 without tax liability but must file gift tax return.


Charity Gifting


According to the poll conducted by Red Cross, While 86 percent of Americans reported their personal finances are the same or worse than last year, 72 percent expect to give the same amount or more than last year to charity. The poll also shows that the majority of givers plan to donate more than 100 dollars which is a good news for charities.


When it comes charity giving, no taxes liability for the donor rather donor would be eligible for some tax deductions depending on the property type and contribution value. To get deductions, you should satisfy certain formalities depending on your contribution amount.

For charitable contributions of less than $250, you must keep a canceled check, credit card receipt or electronic funds transfer receipt. Or you must have a letter from the charity acknowledging receipt of the contribution and stating its date and amount. If its $250 or more, you’ll also need a written receipt from the charity substantiating the amount of cash contributed and a description (but not the value) of any property — other than cash — contributed.



And you must disclose whether the organization provided any goods or services (such as a theater ticket or dinner) in return for the contribution.
If you donate property, such as clothing, valued at less than $250, you must keep a receipt from the charitable organization showing the charity’s name, contribution date, physical location of the contribution and a detailed description of the property (but not its value).



For larger donations, you’ll need even more documentation, including a description of how you acquired the property (purchase, gift, inheritance), the date you acquired the property and the original cost of that property. Donated property worth more than $5,000 requires a qualified appraisal, as do lesser-value objects that aren’t in “good” condition. 

Any personal service or volunteering your time won’t be eligible for deductions. But your commute mileage to volunteering would be eligibe. Also there is 50% and 30% AGI limitation on your contribution depending on the type of property and type of charity donated.  Also if a Tangible property like sofa or anything is not put in use for the purpose, it will have deduction limited to 50% FMV.



Any gifts to political organizations are not subject to gift tax, nor are they tax deductible.



In this Web 2.0 age, there are lot of ways to give with a click of a button. You can check websites like CharityNavigator, GiveWell, Philanthropedia  to contribute or check out VolunteerMatch.com to match with organizations to volunteer your time.

Business Gifting


If you are self employed or in business, you have to honor the relationship with people like clients, associates, and employees  in your buiness during this holiday times. Even small gifts goes a long way and those gifts are deductible up to $25 per year per recipient and deduct them on your income tax return. Mailing and wrapping paper, gift cards are considered are not included in the $25 cap.


But unfortunately $25 won’t be enough to satisfy different types of business people, and you might need to spend more than $25. In that case you have an option. You could take them out for dinner/lunch and claim it as meals and entertainment expense. These expenses are subject to a 50% hair cut but atleast better than a cheap $25 gift right!


Conclusion

Whether you are giving to family member/friends or to a charity or business related people, just keep in mind that you not only making someone happy but also making yourself indirectly by getting deductions or sharing your wealth. So give generously to charities and carefuly to others to avoid taxation.

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Tax Planning – Stock Investment Strategies – II

April 27th, 2010 Vijaianand

In the last couple of posts, we been looking at how Tax planning can have an effect in your tax preparation. We saw the difference between Tax Planning and Tax preparation. We also started digging in deep on how the cost basis and stock selling strategy can save you some money. In the previous post, I started explaining about different types of determining cost basis and will complete in this post. At the end of this post, you will know which methods helps on different situations. So read on.

Check out the cost basis using FIFO method before moving on to read so you can better understand the difference.

Average cost is another method for determining cost basis and is only used with investment/mutual funds. To determine the average cost, the total cost of all shares purchased including any invested dividends is divided by the total number of shares held.


Once this method is used, it must be used each time the taxpayer sells shares in a mutual funds. This method is most effective if the shares purchased first have the lowest cost basis.


Average cost has 2 different ways of calculating according to the stock purchased periods. The single category method is when the investor takes all of the purchase amounts and divides by total number of shares owned. The double category method sorts the total shares owned into a short-term and a long-term holding period. Then, the average cost for each category is identified.


For example, Jan buys the Vanguard growth fund

  • 200 shares on January 3, 2001 at $20/share

  • 300 shares on September 5, 2002 at $25/share

  • 200 shares on April 20, 2008 at $22/share

On Oct 15, 2009 she sold 500 shares at $20/share. What is her cost basis according to the average cost method?


According to the single category average cost method, she would take an average of the purchase prices and divide by the total number of shares owned:

  • 200 shares at $20 = $4,000

  • 300 shares at $25 = $7,500

  • 200 shares at $22 = $4,400

  • Total cost = $15,900

  • Total shares = 700

  • Average cost per share = $22.71

So the gain/loss for this sale was:

  • 500 shares ($20 – $22.71) = -$1135.50

Therefore, Jan had a net loss of = -$1135.50


The specific share identification method implies that specific shares are used to apply against the shares sold.


Before selling shares, the shareholder must inform the broker or fund company regarding which shares are to be sold. These instructions must be given at the time of sale or transfer, not later. The broker or agent must confirm this request within a reasonable time after the sale.


This method can be used effectively only if the shareholder has kept accurate records and has followed through on the receipt of confirmations from the broker. It allows the shareholder to control the capital gains taxes that he or she has to pay because this can be determined by selecting the shares to sell. You can tell your broker to sell your highest-cost shares when unloading part of your holdings in a stock. Using this “specific ID method” requires you to identify the shares to be sold by specifying their cost and purchase dates. You must also receive a written confirmation of your instructions from the broker or keep a record of your oral instructions. Put this in your tax file for safekeeping.


Which method is suitable and when?

Specific ID method is the best method for tax purposes because the investor has absolute control over how much the gain from a sale would be. Long term or short term gains can also be controlled. This is the preferred tax basis method for investors who actively manage their portfolio for tax efficiency. It is also not the most cost effective because of all of the effort that is required for proper record-keeping.


If you don’t follow th procedure, you must use the first-in, first-out (FIFO) method, meaning the shares you bought first are considered sold first. Those were likely the cheapest — giving you the biggest possible tax hit. The point to remember is that you must take action at the time of sale to use the specific ID method.

Short term Vs Long Term

If you have both unrealized gains and losses in your portfolio, but want to make some sales in a certain way matching them property to get the best effect.  First, the general rule is try to sell long-term holdings (held over 12 months) first to benefit from the 15% maximum long-term capital gains rate. Then, unload your short-term holdings.


Then in order to offer offset those gains, you can sell the loser stocks for loss to balance it out. You will generally get the most tax-saving for the buck by selling short-term holdings for a short- term loss by taking advantage of short-term losses offsetting short-term gains which would otherwise be taxed at the regular income tax rate and any leftovers then offset long-term (15%) gains.

By following the above strategies matching your situation, you can either save some money by not paying to uncle sam way beyond the tax season. That concludes the tax planning – Stock investment strategy by doing cost basis analysis.

Posted in Financial Literacy, Stock Market, stocks, Tax Planning, Taxes Tags: , No Comments »
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