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Want To Shift Income? Give It Away

With three key tax provisions that took effect in 2013 raising the ante for high-income earners, you may be inclined to look for ways to shift income-producing assets to family members in lower tax brackets.  That can be effective, as long as you’re comfortable with the trade-offs.

By now, you know about the tax changes affecting those in upper-income brackets.  There’s a higher top rate for income—now 39.6%, up from 35%, which applies to single tax filers with income above $400,000 and joint filers above $450,000.  There also has been a tax hike on capital gains and qualified dividends, with the usual maximum 15% rate for long-term capital gains and qualified dividends jumping to 20% for tax filers above those same income thresholds.  And, finally, there’s the Medicare surtax, a new 3.8% tax that applies to the lesser of net investment income or the amount by which your modified adjusted gross income exceeds $200,000 for single filers and $250,000 for joint filers. 

What is the end result?  If you earn enough, you might be forced to pay a combined 43.4% tax rate on some of your income, and that doesn’t even count additional state or local income taxes.

To lighten this heavier tax load, there are several possibilities, including sophisticated trust arrangements.  But by far the simplest—and potentially one of the most effective—ways to shift income is to give outright gifts to your children or to other low-taxed family members.  Not only will the earnings from property you give away be taxed to your offspring—instead of to you in your higher tax bracket—but you also may be able to reduce or eliminate the 3.8% Medicare surtax.

Suppose you’re in that combined 43.4% tax bracket and you shift $10,000 of annual taxable income to each of three children in the 25% tax bracket and two grandchildren in the 15% bracket.  You’ll save a total of $11,200 in taxes, this year, next year, and every year until the rules change again.  (You will, however, have to watch out for the “kiddie tax,” which calls for unearned income above a threshold—$2,000 in 2013—received by a dependent child under age 24 to be taxed at the parents’ top tax rate. 

Though transfers to your kids are subject to gift tax, you can use the annual gift-tax exclusion ($14,000 per recipient in 2013) to limit that liability.  And the annual exclusion is doubled for joint gifts by a married couple. If there’s an excess, it may be covered by the lifetime gift-tax exclusion ($5.25 million in 2013). Similarly, direct gifts to grandchildren are sheltered from the generation-skipping tax by an exemption of the same amount. 

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