Overview

Main Menu Name: Inc. Shift

This model calculates the federal income tax saved from shifting investment income from a parent in a higher income tax bracket and a child (over the age of 18) in a lower tax bracket, showing both the projected savings in the first year and the cumulative savings over time (in 5 year increments).

In this article:

• Background
• Getting Started
• Entering Data
• Results

Background

In addition to saving federal estate tax (and possibly state death taxes), lifetime gifts within a family can save income taxes for the family as a whole when gifts of income-producing investments are made by a higher-income taxpayer to a lower-income taxpayer, because the investment income is then taxed at lower tax rates.

This model calculates the federal income tax saved from shifting investment income from a parent in a higher income tax bracket to a child (over the age of 18) in a lower tax bracket, showing both the projected savings in the first year and the cumulative savings over time (in 5 year increments).

The model starts with the value of the investment and the yield on the investment, the taxable income of the parent (donor) and child (donee) other than the income from the investment, and the filing status of the parent and child (married filing jointly, married filing separately, unmarried, and head of household), and calculates the tax on the investment income in the hands of the parent versus the tax on the same investment in the hands of the child, the top marginal tax for the parent and the child, and the average rate of tax on the investment income for each of them.

The top marginal tax rate is the federal tax rate that applies to the last dollar of income when the investment income is added to the parent's or child's other taxable income.

The average tax rate is the average of the different tax rates that can apply to the investment income when that investment income is added to the parent's or child's other income. So, for example, if an investment produces an income of $10,000 per year and, in the hands of the child, $3,000 of that income would be taxed at 15%, because the child's other income has already "used up" all of the 10% bracket and the rest of the 15% bracket, then the remainder ($7,000) would be taxed at 25%. The average rate of tax on the investment income would then be 22%, because 15% of $3,000 is $450 and 25% of $7,000 is $1,750, for a total tax of $2,200 on $10,000 of income.

The model also assumes that the income produced by the investment are re-invested at the same rate as the original investment.

Note:  This calculation does not include future inflation adjustments, possible reductions in personal exemptions or itemized deductions due to increases in income, the Sec. 1411 tax on net investment income, or other non-rate consequences.

Getting Started

In addition to saving federal estate tax (and possibly state death taxes), lifetime gifts within a family can save income taxes for the family as a whole when gifts of income-producing investments are made by a higher-income taxpayer to a lower-income taxpayer, because the investment income is then taxed at lower income tax rates.

The model starts with the value of the investment and the yield on the investment, the taxable income of the parent (donor) and the child (donee) other than the income from the investment, and the filing status of the parent and child (married filing jointly, married filing separately, unmarried, and head of household), and calculates the tax on the investment income in the hands of the parent versus the tax on the same investment in the hands of the child, the top marginal tax for the parent and the child, and the average rate of tax on the investment income for each of them.

The model assumes that the income produced by the investment is re-invested at the same rate as the original investment for future calculations of income earning.

Note: This calculation does not include future inflation adjustments, possible reductions in personal exemptions or itemized deductions due to increases in income, the Sec. 1411 tax on net investment income, or other non-rate consequences.

Entering Data

To calculate the federal income tax saved through a gift of an income-producing investment, enter the following information.

1. Investment:  Enter the value of the investment to be transferred from the parent to the child.
2. Rate of Return:  Enter the annual rate of return for the investment.
3. Parent's Taxable Income Post-Gift:  Enter the parent's annual taxable income, excluding the income produced by the investment that is being transferred (i.e., the parent's taxable income after the gift is made).
4. Parent's Filing Status:  Choose the applicable filing status for the parent (Single, Joint, Separate, Head of Household).
5. Child's Taxable Income Pre-Gift:  Enter the child's annual taxable income, excluding the income produced by the investment that is being gifted (i.e., the child's taxable income before the gift is made).
6. Child's Filing Status:  Choose the applicable filing status for the child (Single, Joint, Separate, Head of Household).

Results

The model starts with the value of the investment and the yield on the investment, the taxable income of the parent (donor) and child (donee) other than the income from the investment, and the filing status of the parent and child (married filing jointly, married filing separately, unmarried, and head of household), and calculates the tax on the investment income in the hands of the parent versus the tax on the same investment in the hands of the child, the top marginal tax for the parent and the child, and the average rate of tax on the investment income for each of them.

First Year Results

Under the summary tab are the results from the first year, showing the top tax rate on investment income, the avg. tax rate on investment income, and the after-tax rate of return on investment for both the parent and the child, as well as the income advantage of the gift.

The top tax rate on investment income is the top federal marginal tax rates for the parent and the child in the first year, calculated by adding the investment income to the parent's other income and to the child's other income, in order to show the decrease in tax that can result when the investment (and its income) is given to the child by the parent.

The after-tax rate of return on investment is the rate of return on the investment multiplied by the average tax rate on the investment income.

The income advantage of the gift is the difference between the tax that would be paid by the parent if the parent were the owner of the investment and the tax that would be paid by the child if the child were the owner of the investment.

Accumulated Values

The accumulated values tab shows the results in the first year, and after five, ten, fifteen, and twenty years, as the after-tax income is accumulated and reinvested at the same rate of return.

The accumulated income table of results shows the interval of years, the accumulated investment (end of year), the average tax rate on the investment income, and the after-tax rate of return for parent and child. Finally, the table shows the income advantage of the gift and the cumulative income advantage.

Note: These calculations do not include future inflation adjustments, possible reductions in personal exemptions or itemized deductions due to increases in income, the Sec. 1411 tax on net investment income, or other non-rate consequences.