Holiday Cheer Part 3

Today is the final of our three-part year-end financial countdown—we started with using taxable accounts to harvest tax losses; then went to maximizing retirement plans to save taxes and get on track with retirement goals and objectives. Today it’s time to find the real spirit of the holidays and discuss charitable giving.

According to a report published by the Giving USA Foundation, a nonprofit group that supports research and education in philanthropy, U.S. donors gave $295 billion directly to charitable causes last year, up 4.2% from 2005. It’s not just the super-wealthy who dig into their pockets--about 65% of households with incomes of less than $100,000 gave to charity last year, with the average American giving 2% of income and the wealthiest as much as 8% to 10%, the report found.
Most people do not give unless they truly want to give. That being said, Uncle Sam provides some encouragement to those who do make charitable donations. If you are gifting to a non-profit, consider donating appreciated securities in lieu of cash. By giving away stock -- instead of selling it and donating the cash -- you can claim deductions against your federal income taxes for the current market value of shares, and avoid paying capital-gains tax on the appreciation. Most large non-profits can accept stock directly. For a smaller charity that isn't equipped to take stock, contributions can be made through a donor-advised fund or foundation. But don’t wait until New Year's Eve to make stock contributions if you want to include them in your 2007 tax returns --- stock transfers can take weeks.
In addition to gifting stock, an interesting opportunity lies in your IRA account. Consider taking advantage of a law scheduled to expire at the end of this month that could benefit many taxpayers who are over 70½. If you qualify, you can transfer as much as $100,000 this year directly from your individual retirement account to a qualified charity without having to pay income taxes on that money. Also, the transfer counts toward your minimum required distribution for the year. Just make sure the gift is made directly from the IRA to charity. Taxpayers should take advantage of this break this year because it could vanish.

There is one other gifting idea that is set to expire at the end of 2007: the Kiddie Tax Rule. The Kiddie Tax is an obscure tax designed to keep the wealthy from transferring money to their children, who would in turn pay taxes at the child’s, not the parent’s, rate. Those of you with custodial accounts might find that recent changes to the rules result in an increase in taxes in 2008. The good news: there is a window of opportunity between now and the end of the year where you might be able to save on capital gains taxation, if you sell certain assets in 2007.

Here is how it works: For a child subject to the Kiddie Tax, any unearned income (interest, dividends and capital gains) received in 2007 is first exempted from taxation, then taxed at the child’s rate, and finally taxed at the parent’s rate, as indicated in the table below.

Taxation of Child’s Unearned Income 2007
Up to $850* Exempt from taxation
$851 to $1700 Taxed at the child’s rate
Over $1700 Taxed at the parent’s rate
*All figures indexed annually for inflation

Currently the Kiddie Tax impacts children who are under 18. Beginning in 2008, however, dependent children who are 18 will also be subject to the tax as well as dependent full-time students between the ages of 19 and 23. While the rules primarily affect UTMA and UGMA (Custodial) accounts, they can also apply to a child’s individual account once the UTMA/UGMA has been distributed, and to 2503(b) trusts, assuming the child is still claimed as a dependent on your tax returns.

For those who have UTMA accounts, or dependent children with individual accounts, and whose children/students are between the ages of 18 and 22 this year, there is a one time opportunity to sell appreciated assets in order to take advantage of the child’s 2007 5% capital gains rate (up to a child’s taxable income of $31,850). This particularly applies to assets which are earmarked for college and which should be sold in the next few years to pay for tuition costs. The capital gains rate will increase to 15% in 2008 on unearned income above the Kiddie Tax limit. Interest and dividends count too, although most custodial and individual accounts are not large enough to generate sufficient earnings to be taxed at the parent’s rate.

Finally, it’s worth noting that the annual gift tax exclusion permits individuals to give up to $12,000 to an unlimited number of individuals during the calendar year ($24,000 if you are married and gift-splitting is elected), so if you plan to make gift, get going now!