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Tax Savings 101: Fund College And Wipe Out Capital Gains Tax

Posted by McDonald & Osborne Posted on Oct 14 2015

Recently we came across a great college funding strategy for those who earn too much for traditional college aid. Forbes contributor Troy Onink suggests utilizing tax savings to help lower the overall cost of college. In his article , he gives a hypothetical example of how parents could gift appreciated stock over the years to a child who in turn would sell some of the assets during each year of college realizing $25,000 in long-term capital gains. The proceeds would then be used to pay the $46,000 annual tuition at a state university. If carried out correctly, your child’s standard deduction, personal exemption and American Opportunity Tax Credit would offset the $25,000 capital gains tax each year.

It’s important to make sure you are dotting your I’s and crossing your T’s while using such a strategy. For example, you must first make sure that your child is providing more than half of his or her own support by using their own income and assets to pay for college, living expenses, etc. If they do not, you the parent will be entitled to their $3,900 personal exemption and they won’t. If they pass this support test, they will be eligible to claim the full $6,100 standard deduction as well.

The American Opportunity Tax Credit is worth up to $2,500 per student, per year for up to four years. The credit is calculated by taking 100% of the first $2,000 in qualified tuition and fees and 25% of the next $2,000 in fees. Keep in mind, however, that your son or daughter can only take advantage of this credit on their own income tax return if you do not claim them as a dependent and do not take the credit on your return.

Also keep in mind the kiddie tax (on unearned income) now applies to children under age 19 and full-time college students under the age of 24. To avoid the tax, your son or daughter must provide over half of their own support from their own earned income (which includes wages but does not include income from the sale of stocks). This one is obviously difficult to avoid if your child is in school full-time and has minimal earnings from wages. Under kiddie tax rules, the first $1,000 of unearned income is tax-free, the second $1,000 is taxed at the child’s rate and any unearned income over $2,000 is taxed at the parents’ rate. The good news is that the long-term capital gains rate is currently just 15% for most individuals and 20% for those who fall under the highest tax bracket (the 3.8% investment surtax would not apply to your child in this situation).

Illustrative example from the article above:

Long-term capital gains

$25,000

Student’s personal exemption

-$3,900

Student’s standard deduction

-$6,100

Net taxable income

$15,000

Capital gains rate (parents’ rate)

x 0.15

Gross federal tax

$2,250

American Opportunity Tax Credit

-$2,500

Federal tax due

$0


If you have any questions regarding this tax savings strategy or have any other issues you would like to discuss, please feel free to contact our office at anytime.

Stephen Osborne
Accountant
sosborne@mo-cpa.com