I 1-48 and I 1-49

Tax Strategy Problem

I:1‑48

Pedro Bourbone is the founder and owner of a highly successful small business and, over the past several years, has accumulated a significant amount of personal wealth. His portfolio of stocks and bonds is worth nearly $5,000,000 and generates income from dividends and interest of nearly $250,000 per year. With his salary from the business and his dividends and interest, Pedro has taxable income of approximately $600,000 per year and is clearly in the top individual marginal tax bracket. Pedro is married and has three children, ages 16, 14, and 12. Neither his wife nor his children are employed and have no income. Pedro has come to you as his CPA to discuss ways to reduce his individual tax liability as well as to discuss the potential estate tax upon his death. You mention the possibility of making gifts each year to his children. Explain how annual gifts to his children will reduce both his income during lifetime and his estate tax at death.

I would advise Pedro that the gifts that he gives to his children would no longer be his assets and if these are income producing assets then the interest on those assets will not be taxable to him they would be taxable to his children at their rates. He could make annual gifts of $13,000 of stocks and bonds now and future years to each of his children. The effect of these gifts are to shift the dividends and interest from Pedro (at his high rate) to the children (at their low rates) as well as removing these assets from Pedro’s estate upon his death. Since the children have no income, the dividends and interest would be taxed to the older two children at the lowest marginal income tax rates. The younger child will be taxed at his parent’s rate for much of the income shifted to him per the so-called “kiddie tax.” Thus, the shifting of investment income is not effective for children under the age of 18 (or 24 and in college). Also, as will be discussed later, Pedro and his wife can...