Gifts of Appreciated Assets May Offer Attractive Alternative to “529” College Savings Plans

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Gifts of Appreciated Assets May Offer Attractive Alternative to “529” College Savings Plans
June 1, 2005
From the June 2005 Riker Danzig Tax and Trusts & Estates UPDATE.
Area(s) of Practice:
Estate Planning & Administration, Tax Law

Under federal tax law changes enacted in 2001, the capital gains tax rate for individuals in the 15% or lower federal income tax bracket (taxable income not over $22,100) is reduced to 5% through 2007 and 0% beginning in 2008. While children under age 14 generally are taxed at their parents' tax rate, children age 14 and older are taxed at their own (generally lower) tax rate. As a result, if the child (or the custodian of a Uniform Transfers to Minors Act - "UTMA" - account for the child) sells an appreciated asset (e.g., stock), and the child is at least age 14, the gain could be taxed at as little as 5% through 2007 and then at 0% in 2008. If you want to use appreciated assets to fund a child's or grandchild's education, it therefore may be advantageous to give them the appreciated asset, as opposed to funding a 529 Plan, since only cash can be contributed to a 529 Plan.

For example, assume you own 200 shares of XYZ corp stock with a cost basis of $2,000 and a current fair market value of $20,000. If you sell the stock and then contribute the cash proceeds to a 529 Plan, you will have $17,300 after tax to contribute (15% federal tax on $18,000 gain is $2,700). Compare this amount with a contribution of the stock to a UTMA account - you contribute the stock worth $20,000, but if the stock is sold before the end of 2007, the custodian will be left with $19,100 after tax (5% federal tax on $18,000 gain is $900). If the stock is sold after 2007, the custodian will have the full $20,000 cash proceeds (tax free) available.

Although this reduction in capital gains tax rates may be attractive, it is only one of the factors you should consider. Other factors, such as whether you want to retain control over the account assets, the purposes for which you may want to distribute the assets (assets withdrawn from a 529 Plan that are not used to pay qualified educational expenses are subject to a 10% penalty), and gift and estate tax consequences, should be discussed with your attorney or tax advisor before deciding which strategy is best for you.