After reaching age 14, a youngster is treated as a single taxpayer: he or she will be taxed at 10 percent or 15 percent, up to $29,700 in taxable income in 2005. Within that income level, capital gains will be taxed at only 5 percent. Therefore, children who have reached age 14 should be given appreciated assets you intend to sell.
Suppose, for example, you and your spouse own shares of XYZ Corp. that you wish to sell. In 2005, you can transfer $22,000 worth of those shares to a custodial account for a child 14 or older, tax-free.
Suppose those shares were bought many years ago so your cost basis in the transferred shares is $5,000. If you had sold the shares yourself, you’d have a $17,000 long-term capital gain and a $2,550 tax bill, at 15 percent.
After the transfer, though, the child’s tax rate will apply. Your 14-or-older child retains your holding period and cost basis. Thus, if the child’s custodian sells the shares, there will be a $17,000 long-term gain, taxed at only 5 percent, for an $850 tax bill. The after-tax sales proceeds of $21,150 can remain in the youngster’s custodial account, where further investment income will be taxed at a low tax rate.
What’s more, under current law the 5 percent rate on long-term gains for low-bracket taxpayers will be zero percent in 2008. Thus, you should plan for sales of appreciated assets from custodial accounts that year.
