When they got their first glimpse of their tax return’s bottom line this year — whether they were due a refund or owed m oney — lots of affluent taxpayers felt a jolt. That feeling is likely to repeat, although advisors can help their clients better prepare for their tax burdens.

“Many of our clients were surprised to see how much more they owed in tax for 2013 when their returns were prepared this year,” says Michael Eisenberg, a CPA who heads a financial advisory firm in Los Angeles. “Some received much smaller refunds than they expected. There’s a lot of interest in seeing what can be done to hold down future taxes.”

Well-off clients were subject to sharply higher effective tax rates on the wealthy that includes higher rates on income, qualified dividends and long-term capital gains. In addition, surtaxes apply to earned and net investment income, and there’s an income-based phaseout of the tax benefits of itemized deductions and personal exemptions.

Since the changes were aimed at the wealthy, they opened the door to greater income-shifting tactics within families. But be wary, Eisenberg says: Such tax-saving moves often involve both financial and nonfinancial issues. “Look at the big picture before making major decisions,” he says.


One area of opportunity for affluent planning clients likely to have investment income is shifting unearned income to less wealthy descendants.

A 0% tax rate makes the income shift especially alluring. “Clients may have children or grandchildren who are generally in the 10% or 15% tax brackets,” says Marty Abo, who heads a CPA firm in Mount Laurel, N.J. “For them, the federal income tax rate for 2014 is 0% on qualified dividends and long-term capital gains.

“Clients could consider giving children or grandchildren assets such as mutual fund or stock shares with a low tax basis that the clients plan to sell,” Abo suggests. “Assuming the clients have held the assets for over a year, the youngsters could then sell them to use the 0% tax rate.”

For 2014, single taxpayers whose taxable income (after deductions and exemptions) is no more than $36,900 will owe zero tax on qualified dividends and long-term capital gains. For married couples filing jointly, the cutoff for zero tax is $73,800 of taxable income. (In 2015, those limits rise to $37,450 and $74,900, respectively.)

Thus a high earner who wants to trim exposure to the soaring stock market but could owe upward of 25% in tax on realized long-term gains might give his daughter the shares he plans to sell. If her total taxable income for 2014 is below $36,900, she would owe 0% tax on those sales.

“Similarly, giving dividend-paying stocks to recipients in the 10% to 15% tax brackets will have the dividends taxed to them at 0%,” Abo says. But he adds a caution: “Just note that the kiddie tax rules’ could potentially require such capital gains and dividends to be taxed at the parents’ higher rates.”

That “kiddie tax” could effectively limit savings to a few hundred dollars a year. If a teenage daughter has no other income in 2014 besides a $10,000 long-term gain from selling the stock she got from her father, her gains would be taxed in two increments. The first $2,000 of that unearned income (the 2014 ceiling; in 2015 it will be $2,100) would get the 0% tax rate; the other $8,000 — and any other unearned income — would be taxed at her father’s rate, subject to all the tax code provisions.

Which youngsters are subject to the kiddie tax? The definition is a bit complicated, but generally children qualify until they leave school or hit age 24, whichever comes first.

Asset transfers to age-qualified young adults in low-earning early-career jobs or still in school could also move long-term capital gains into the 0% tax bracket.


Asset transfers to clients’ parents won’t be affected by the kiddie-tax rules — and indeed, many middle-aged workers already provide financial help to retired loved ones. If a client is in that situation, transferring appreciated assets to the parents can be a tax-effective solution, perhaps followed by investing the proceeds in stocks or funds that pay dividends likely to be taxed at 0%.

If the long-term gains are realized by a married couple in retirement, the $73,800 income ceiling may leave ample room to take gains taxed at 0%.

Carol Wright, a tax principal with Rehmann, a financial services firm based in Troy, Mich., notes that family business and real estate assets may also be involved in income-shifting plans. “We’ve used family limited liability companies for some clients,” she says, “and reducing income taxes may be one of the results.”

Eisenberg mentions a similar outcome from the use of family limited partnerships.

With either FLPs or family LLCs, clients transfer assets to the entity, which then transfers some interests to other family members. “There might be valuation discounts on the transferred assets,” Wright says, “resulting in gift- and estate-tax benefits. It’s also possible to transfer different types of interests to various recipients, so that lower-bracket relatives get income interests, for instance.”

Eisenberg notes that the LLC or FLP documents should express motives beyond tax reduction, like a desire for creditor protection or providing young family members with experience in managing specific assets.

Another strategy revolves around shifting income out of a trust. “We work with some families where income-producing assets are held in trust,” says Mira Finé, a tax partner with Hein & Associates in Denver. “Trust income reaches the top 39.6% tax bracket at a very low amount — $12,150 in 2014 — while the 3.8% [Medicare surtax] also may apply to trust income over that amount. Therefore, it can make sense to distribute some income to the trust beneficiary, who might be in a much lower effective tax bracket.”

If unearned income is distributed from a trust to a young beneficiary, there might be three taxpayers with brackets to use: the trust, the beneficiary and the beneficiary’s parents. Careful distributions from the trust could result in significant tax savings.

But, Finé adds, advisors may have to take steps to see that the purposes of the trust, which could include limiting cash flow to certain beneficiaries, are not disrupted by distribution decisions made to save taxes.


While many clients shift investment income to lower-bracket relatives through asset transfers, additional tactics might be used by self-employed professionals or business owners.

“They may be able to hire their children,” says Ed Mendlowitz, a partner at CPA firm WithumSmith+Brown in Princeton, N.J. “If kids are away at college, for example, the parent might pay them to do market research there, if that makes sense for the company’s business.” Alternatively, a retired parent could be paid to provide advice derived from experience.

In any case, the employer should keep records showing the employee received acceptable wages for work actually performed and file any applicable payroll tax returns.

“By paying children, those wages may be deducted as a valid business expense, thus reducing the company’s net profits, which then reduces one’s income,” says Jessie Seaman, business tax team leader of the Tax Defense Network in Jacksonville, Fla. She points out that the kiddie tax mainly applies to unearned income, so larger amounts can be shifted by hiring children. 

“Even if a son or daughter is claimed as a dependent, the youngster can work for the parents and earn up to $6,200 in 2014” — the standard deduction amount — “income tax-free,” Abo says. “An added benefit can be reaped because legitimate wages can be used to qualify the youth for opening a Roth IRA.”

There are even more tax advantages available if clients do business as certain types of LLCs, a parental partnership or a self-employed individual. “In those situations,” Abo says, “there are no Social Security or Medicare payroll taxes on reasonable wages paid to a son or daughter under age 18. Thus, a husband-and-wife partnership could hire their children who are under 18 and avoid those taxes. In addition, there is no federal unemployment tax if the son or daughter is under 21.”


Along with all the tax benefits of income shifting, clients should consider a few drawbacks.

One that’s perhaps obvious: Assets shifted to relatives are no longer owned by the giver. “Advisors should be confident clients won’t need the assets they’re giving away,” Eisenberg says. And the sale proceeds may not be used wisely by inexperienced youngsters or aging parents. Asset transfers also may have gift tax consequences, while FLPs and family LLCs may require expensive professional advice.

Similarly, clients who pay their children substantial amounts should document the process carefully so the tax benefits will survive any IRS challenge. “In many situations, relatives with earned income will owe payroll tax,” Mendlowitz says, adding that planners may have to do some number crunching to calculate the ultimate tax savings. “The amounts owed may offset some of the tax savings of income shifting.”

Donald Jay Korn is a contributing writer at Financial Planning.

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