The federal gift tax law imposes a tax on the transfers of property you make to your children if it doesn't qualify for an exemption or exclusion. Moreover, it's irrelevant whether you make the gift in cash or with shares of stock, nor does it matter if the children use the proceeds to pay college expenses or to finance a vacation. However, there are alternative ways to make the gift that avoid the tax entirely.
Gifts of Stock
Knowing what the adverse tax implications are of gifting stock to your children is essential to understanding how to utilize basic tax-advantaged gift-tax planning tools. If the Internal Revenue Service requires you to include the stocks in your taxable gifts, it will calculate your tax liability on the fair market value of the stocks on the day you make the gift, rather than your cost to acquire them.
Pay College Directly
If your intention is to provide your children some financial assistance with their college expenses, you should first take advantage of the exemption for educational expenses that the IRS permits. Provided you make a direct payment to the college to pay for the school expenses of your children, the IRS allows you to exempt the entire payment, regardless of amount, from the gift tax. However, this may require you to liquidate your stock holdings in order to obtain the cash necessary to make the payment.
If you sell the stocks for more than you purchase them for, the transaction will result in a capital gain. However, if you have capital loss remaining from prior years, or incur them in the current year, you can offset the gain on your stock transaction with those losses. Moreover, if you own the stocks for more than one year prior to the sale, the gain is subject to lower rates of tax than short-term gains, which are owned for one year or less. Although the gift-tax rates frequently change, they are generally much higher than the maximum rates the IRS can use to calculate the tax you owe on capital gains
Use Annual Exclusion
Choosing not to sell your stocks to pay the college expenses of your children doesn't necessarily mean you will pay tax on the gift. The tax code provides for an annual exclusion, the amount of which is subject to change from year to year. For example, in 2011 the law allows you to use a $13,000 annual exclusion for each of your children. Effectively, this means you can gift each of them stock worth $13,000 and avoid the gift tax entirely. However, if the value of the stock you provide to a child is greater than $13,000, the excess is a taxable gift.
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