Gifts to Parents Involve Some Risks
Q. Every year I put $20,000 into my parents’ brokerage account as a gift. The stock generates some welcome dividend income for them and, because they are in a low-income tax bracket, the income is not eaten up by taxes. I will eventually inherit their estate, which, because of its relatively small size, should not be subject to estate taxes. My plan seems sound to me, but I worry about any potential income tax ramifications that I haven’t thought of. What do your experts say? -- R.R.C .
A. Your plan passes muster with the experts, with a few caveats. First, let’s explain why the experts like your strategy: By giving your parents cash that can be used to purchase an appreciable asset, you stand to inherit securities investments whose tax basis will be stepped-up upon the death of your parents. This means that the cash you give them can grow without generating a tax liability for you. Further, because your parents are in a low tax bracket, they can take maximum advantage of the dividends that these investments generate over the course of their lives.
Now let’s discuss the potential pitfalls: First, you should be sure that the total value of your parents’ estate does not exceed the federal limits on the amount that can be passed on to heirs free of estate taxes. (These limits are $600,000 per person or $1.2 million per couple if all the assets are held in joint tenancy or as community property.) You should also be aware that your parents are under no obligation to leave their estate to you. If there is any indication that they are under such an obligation, your annual donations into their brokerage account can be deemed to be an incomplete gift.
Finally, you should realize that any money invested in the stock market or other securities is not completely secure; not only could the account not grow, the principal could be at risk. Your parents are also free to use the proceeds in the account as they wish over the course of their lifetimes. They could be needed for medical expenses, another emergency--or maybe a trip around the world! Remember, if you have truly made a gift of the funds, you have no say over how they are used.
Social Security Benefits Refused After Divorce
Q. In a recent column you discussed the rules governing divorced spouses receiving Social Security. You said a couple had to be married 10 years for one spouse to claim benefits on the other’s account. My Social Security representative refused my claim because I had been married only 17 years. Am I being given incorrect information? -- L.M .
A. A representative of the Social Security Administration says the 10-year marriage requirement--which replaced the 20-year requirement in 1978--applies to all Americans with only one exception: certain, older government employees who were not covered by Social Security. The question you must answer is: Were you eligible to receive, or were you actually receiving, a government pension of any type before Dec. 1, 1982? If the answer is “yes,” then you must have been married 20 years to qualify for spousal Social Security benefits; if “no,” then the requirement is 10 years of marriage.
Although you did not say whether you were a government employee or give your date of retirement or age, Social Security representatives say that it is highly unlikely that you are affected by the 20-year rule if you were born after 1920. You should revisit your local Social Security Administration office immediately if you have been given misinformation by them.
Reporting Foreign Property Sale to IRS
Q. I recently sold some property in a foreign country. I paid all taxes from the transaction to that country’s government, which has a reciprocal tax agreement with the United States. I am a citizen and resident of the United States. Do I have to report this transaction to the IRS? If so, how do I do it? --A.B .
A. You must report the sale. But beware: Even though the United States has a reciprocal tax agreement with the country in which your property is located, you may not be eligible for a complete credit on those taxes. Here are the steps you must follow:
Proceeds from the sale should be listed on Schedule D. You should compute your foreign tax credit by completing Form 1116. Instructions on the form will take you through the steps necessary to determine what portion of the taxes you paid to the foreign country will be credited against any tax obligation you have in the United States. The critical factor in determining what portion of the taxes already paid qualify as a credit is the tax rate imposed by the foreign country on your income compared to that of the United States. If the foreign country’s rate is higher, the IRS will not give you a full credit for those taxes.
Bounty Hunter’s Logic Looks Full of Holes
Q. A friend of mine works as a bounty hunter, hunting down people who have jumped bail. He argues that his income is tax-exempt because the bounty he receives is a redemption or rebate. He compares it to the cents-off coupons offered by grocery stores and the dollars-back rebates so popular among auto manufacturers. Can this possibly be right?-- G.F .
A. Absolutely not! Earned income is taxable no matter what. Your friend cannot get around this no matter what he claims. His payments are neither a gift nor a rebate. He is simply being paid a portion of the amount owed by the person he has found.
And if you think about it, how could his payments be considered a rebate? A rebate is simply the lowering of a purchase price; you have to spend money to get it. Your friend is doing nothing more than devising an elaborate excuse for cheating on his taxes.
