Have you ever heard of the term arbitraging tax rates? It sounds intimidating but in actuality it’s simple, and it’s most likely something you’ll want to put into effect if you can.
Tax arbitrage is a way of restructuring your transactions or profits in order to pay the least amount of tax. Basically, we’re taking advantage of tax codes to get a better deal.Nerd Language!
Here’s an example of how you can put this in motion specifically by giving a gift or a donation to your favorite charity, your church, or even a loved one. Yes a loved one, so read on, friend!
First of all, tax arbitrage is frequently used when dealing with property that has increased in value from its initial purchase price, known as appreciated value. As you know, property can come in many different forms ranging from real estate to stocks.
For this scenario, we will use stock as an example and let’s say you bought Apple.
The day you bought it, it was valued at $5,000, but over time that stock increased in value and is now worth $20,000. This is a capital gain of $15,000. You might be wondering if you now owe taxes on that $15k?
Yep. But, keep in mind, you will owe taxes on this capital gain based on two things:
- Your current income tax bracket.
- Only after you sell the asset which, in this case, is your newly appreciated Apple stock.
Now, if you’re like most of our higher end clients, there is a good chance you are in the top tax bracket which makes your capital gains tax 20%. It’s also worth mentioning, you will owe an additional 3.8% Net Investment Income Tax.
That’s a total of 23.8% you will be taxed on that $15,000. Ouch!
So, enough math, how do we get that 23.8% down to 0%? Let’s go back to that Apple stock we talked about.
Well, as mentioned above, a great way to do it is through giving money or in this case, gifting your stock.
Let’s use a family member for this example and assume you want to gift money to your parents. In this scenario, they make under $78,751 a year, which is the cutoff amount necessary for this strategy to work in favor of you and your parents.
You start by gifting them the $20,000 worth of Apple stock. Your parents can then sell the $20,000 stock and even though the capital gain was $15,000, since it was a gift from you to them, they would literally pay a whopping ZERO capital gains tax.
You pay $0 tax since you gifted it to them and they paid $0 capital gains tax, after they sell it, since it was a gift from you! Killer strategy not to mention your parents would also be receiving $20,000 which, I’m sure, they would be happy about as well.
The rule is: you can give $15,000 per person, to as many people as you want, and if you’re married that number increases to $30,000.
Quick note: if you’re giving more than $15,000 per person, all you would need to do is a gift tax return for documentation.
Pretty cool, right?
This is a fantastic strategy to reduce your taxes and boy is it a great way to give!