Help! Zaidy’s Chanukah Gift Blew Up Our Finances!

January 15, 2023

Stocks

Although kollel wasn’t really his thing, Chaim Haber’s grandfather had always been supportive of his grandson’s path in life. Zaidy Haber often sent a check for Yom Tov, but last year’s Chanukah gift of $20,000 in Apple stock was driven by tax planning. Zaidy’s accountant recommended this move; Chaim was in a much lower tax bracket than his grandfather, and upon the sale of the highly appreciated investment, he could keep more of the proceeds. But after the stocks were sold, Chaim’s accountant explained that though there was indeed little tax due, he’d lost $20,000 worth of tax credits and government assistance!

How did this savvy strategy blow up in their faces?

Tax Win Equals Programs Loss

Zaidy’s accountant was correct on the narrow tax gains issue. But his overlooking the broader perspective turned a good strategy into a terribly costly one. The gain from the sale of the gifted stock is considered income for Chaim. This “unearned” income disqualified him from an earned income tax credit worth $10,000. The stock profits also pushed the younger Habers over the very low eligibility limits for Jersey Care’s health insurance for adults, which can easily be worth $10,000. It’s obvious that a $20,000 gift that loses the recipient $20,000 is not a savvy idea. Since Zaidy’s accountant is only accustomed to wealthy clients, his advice backfired when it collided with the unique situation of a kollel family. Let’s dig a bit deeper into the strategy, what went wrong, and what would have been a better course of action.

Tax Bracket Swapping

As taxable income rises, so does a greater percentage of that income go to Uncle Sam to help pay the country’s bills. Since the capital gains in question here are long-term, even middle-income people can often sell investments without paying any federal tax. (Ask your accountant about these 0% federal capital gains rates.) Therefore, from a tax rate perspective, it makes good sense for high-income Zaidy to gift the stock shares to a low-income relative before the sale. This way, the stock’s gains would be taxed at the relative’s 0% federal tax rates on long-term gains versus Zaidy’s almost 24%. Even counting NJ taxes (which range from 1.4%–10.75%), by shifting the ownership before a sale, the tax owed on $20,000 of investment gains can easily fall from over $6,000 to under $600!

Triggered Social Program Cliff

While the tax shifting saved thousands from the tax collection department, it triggered a backlash from poverty prevention parts of the system. And unlike the tax collection world, where costs tend to go up slowly, the benefits from social programs can fall like a stone off a cliff. The basic logic is that once your income is above the cutoff, you’re not poor enough to need assistance. But this works out illogically. Even a one-dollar rise in income can trigger the loss of $10,000, pushing the person $9,999 backwards into poverty! This social assistance cliff is triggered on earned income tax credits often worth $5,000–$10,000. By having even a penny of investment income above $3,600 you lose all the credits!

Similarly, a family of five is eligible for free adult health care with earnings up to $41,640. But at $41,641 they get kicked off, requiring the purchase of insurance that may cost of dollars. Unaccustomed to these illogical but unyielding cliffs, Zaidy’s accountant had pushed his client’s family over the edge.

Could’ve Would’ve Should’ve

Because of these social benefits cliffs, it would have made much more sense for Zaidy to bite the tax bullet, pay the $6,000, and just gift the remaining $14,000 in cash. The present would have seemed a lot smaller (versus the $20,000 in stock), but the net gain to Chaim would have been a lot larger ($14,000 net versus $20,000 gift – $20,000 programs = $0 net). Or, perhaps Zaidy could have gifted Chaim cash and kept the tax swapping for relatives whose income are too high for social assistance programs but too low to owe a lot of capital gains tax. A really smart strategy to consider would have been to gift the stock to charity in lieu of cash Zaidy was donating anyway, and instead give the $20,000 in cash to Chaim.

Gift Big With Caution

There are many ways to lower the tax bite, but considering the entire big picture is crucial. Very possibly, the accountant wasn’t given enough information and the debacle here was the client’s fault. Be that as it may, if a Chanukah gift involves real money, proceed with caution.

Just by the Way: Accountants are Specialists Too

Would you ask a heart doctor to look at an ingrown toenail? An optometrist to opine on a broken bone? In the field of medicine, everyone understands that there are category specialists and consulting the wrong expert is silly. While a cardiologist knows more about foot anatomy than a layman, his expertise is very limited beyond his primary focus on hearts.

The tax code itself is vast, and accounting covers much more than just tax. Even so, people expect their accountant to know and advise on everything money related. Many will ask an expert in real estate tax rules about business profit margins or estate planning. This misunderstanding of accounting roles leads to poor results and frustration all around. As with all professions, clients are best off using accountants who specialize in their industries, size, and “problem.” And if a general accountant recommends bringing in a specialist to advise on a niche question, it should be respected. Just like a skilled doctor who occasionally recommends a medical specialist, the accountant who sticks to their expertise is likely to produce the best results.