Moral/Ethical question for all the Accountants out there (anyone else too)

[Mister Fancypants]

So I have a moral/ethical question to ask all the accountants on the forum. This is purely hypothetical but something that has crossed my mind recently unfortunately as there have been deaths in the family.

So I was thinking and began to wonder what the ethics, moral and legal implications of this would be.

Spouses have the ability to give unlimited gifts to each other, if one spouse was terminally ill let’s say with cancer or something with a given timeline to death. So with the death of one spouse imminent would it make sense to have the spouse who is dying gift all of their losses to the surviving spouse to prevent a step-up in basis and conversely have the surviving spouse gift all of their gains to the dying spouse to get the step-basis to prevent any taxable event ever. If you are given weeks or months to live and were to do this it would be hard pressed to show it was done strictly to avoid taxes, compared to say the day before death. Transferring securities between mine and my wife’s accounts via our joint brokerage account can be done online in a matter of minutes, so this is not a completed paperwork intensive task by any means. In situations where the total asset base is below the estate tax limits federally and/or state limits there is no concern at all for any type of taxes on the estate side, if you have a huge amount of assets, there might be other considerations.

Also to take this a step further, a dying parent or grandparent can gift losses to children/grandchildren to preserve the cost basis rather than be stepped up, even if it is within the 5 year claw back for estate tax purposes if applicable, the capital loss would be lost in an inheritance with a step-up while preserved in a gift, the estate tax would exist either way if the death occurs within 5 years of the gift/inheritance.

So my question is this morally/ethically a good or bad idea and are there any legal implications?

Also how likely do you think someone is to carry it out when a loved one is dying? I know my family always talks big that when someone dies the first thing you do is run to the bank and empty the safe deposit box, don’t do anything else first… Yet in reality when death really hit, the safe deposit box was the last think on anyone’s mind.

-Mister FancyPants

[Señora Savings]

The ethical question seems to be the oft asked "may one take advantage of the unintended consequences of various laws?"  People don't seem to agree on this.  I wouldn't do it personally, but that's mostly because it seems like a big pain in the ass at a hard time.  Either you have hella cash, in which case, don't put yourself through that to save 15% capital gains, or you don't have much money, in which case you're hardly saving anything and you probably don't have to pay capital gains if you play your cards right.  I guess I wouldn't have a moral problem with someone who did that, but I probably wouldn't want to be their friend either.

I have some serious doubts that a spousal gift would cause a step up, but I live in a communal property state.

[Mister Fancypants]

The ethical question seems to be the oft asked "may one take advantage of the unintended consequences of various laws?"  People don't seem to agree on this.  I wouldn't do it personally, but that's mostly because it seems like a big pain in the ass at a hard time.  Either you have hella cash, in which case, don't put yourself through that to save 15% capital gains, or you don't have much money, in which case you're hardly saving anything and you probably don't have to pay capital gains if you play your cards right.  I guess I wouldn't have a moral problem with someone who did that, but I probably wouldn't want to be their friend either.

I have some serious doubts that a spousal gift would cause a step up, but I live in a communal property state.

Ok you completely missed the entire point of the question...

Lets say I'm terminally ill and my wife has an individual brokerage account with a value of $1m with $500k of capital gains, she can gift me the assets in the account, when I die she inherits the account at market value tax free.

Saving 15% of $500k.

As far as being hard to do I explained the entire process can be done in minutes online, the savings are worth $75k.

Now lets also say I have a portfolio of $1m with losses of $250k, I can gift that to my wife and she now has $250k of capital losses preserved compared to inheriting my $1m at current market rates.

Clearly the portfolios are simplified for the example... but it makes the point more clear.

My wife and I can give each other unlimited gifts, the implication is we know that I am dying and the purpose is to avoid taxes (which is generally illegal), so what is the ethical/moral/legal implication? Since this would be hard to prove as a tax maneuver if executed well and moving assets was not uncommon.

[lurker]

You wouldn't want to gift the depreciated (loss) property because the recipient actually has to take a step-down in basis.  That's the way it works for gifts (you don't get a step-up ever, but you do have to take basis = FMV on date of gift if it's lower).

[Mister Fancypants]

You wouldn't want to gift the depreciated (loss) property because the recipient actually has to take a step-down in basis.  That's the way it works for gifts (you don't get a step-up ever, but you do have to take basis = FMV on date of gift if it's lower).

The intention would be to generate a step-down basis. If I own 100 shares of IBM with a cost basis of $200 and it is trading at $180 and I am going to die of brain cancer in six months my wife will own through inheritance my 100 shares in 6 months at FMV.

If I give her my shares now she now owns them at my cost basis of $200 and in 6 months she still has a capital loss of $20 per share assuming FMV is still $180 per share and I am now dead. Either way she owns the shares but the loss is preserved.

She now has more options on when to take the loss compared to me being forced to take it over the next 6 months, use it or lose it.

Now assume she has AAPL with a cost basis of $100 trading at $200, she can gift it to me and 6 months later she owns it again but now her cost basis is $200 instead of $100 because she inherited from me at my death and it stepped-up to FMV.

[Cheddar Stacker]

It's really just a more complex version of tax loss harvesting and tax gain harvesting. I've never heard of anyone doing this, but then again a year ago I had never heard of the tax gain harvesting strategy either. At least not in the sense of constantly increasing your cost basis whenever you can do so tax free.

It could backfire also I guess. Maybe the wrong spouse ends up dying first. Or god forbid the child dies before the parent.

Either way it's tax avoidance (I don't think it would classify as evasion) and it's up to you to decide how comfortable you are with the strategy. I'm on the fence. I think it's a bit aggressive, but it's smart planning.

Since you're still young and have plenty of time to plan for this in your marriage, maybe this strategy would feel a little less unethical:

Keep a brokerage account for husband and wife. If one spouse is older/unhealthier you could put your more long-term buy and hold plays in that portfolio since they would achieve a step up upon death. The spouse you expect to live longer would hold the more aggressive short-term plays which could result in big losses to harvest more regularly.

[EscapeVelocity2020]

I can see how this would work, and it probably done accidentally by many couples since the husband probably has the brokerage account and is typically the one that dies first (that's the way it'll probably be for me, and also likely tax law will change many times over, so I'll be sure to have my CPA by my death bed :)

I'm not sure it could work between generations (the grandparent example), when it comes to 'gifting a loss' / preserving a lower cost basis.  The gift (even of the stock certificate) would transfer at it's current FMvalue, right?  Best to let it transfer at the stepped-up basis (if appreciated) or take the loss (and offset gains so that carryover losses aren't, uh, lost)...  Could you explain your understanding on this one (since it is more likely to apply to me in the near future than the spouse one).  Maybe I can get those grandparents to gift us any losers they are hanging on to...

[Mister Fancypants]

It's really just a more complex version of tax loss harvesting and tax gain harvesting. I've never heard of anyone doing this, but then again a year ago I had never heard of the tax gain harvesting strategy either. At least not in the sense of constantly increasing your cost basis whenever you can do so tax free.

It could backfire also I guess. Maybe the wrong spouse ends up dying first. Or god forbid the child dies before the parent.

Either way it's tax avoidance (I don't think it would classify as evasion) and it's up to you to decide how comfortable you are with the strategy. I'm on the fence. I think it's a bit aggressive, but it's smart planning.

Since you're still young and have plenty of time to plan for this in your marriage, maybe this strategy would feel a little less unethical:

Keep a brokerage account for husband and wife. If one spouse is older/unhealthier you could put your more long-term buy and hold plays in that portfolio since they would achieve a step up upon death. The spouse you expect to live longer would hold the more aggressive short-term plays which could result in big losses to harvest more regularly.

@Cheddar I was waiting for your insight :) Thanks for the reply!

I agree it is just another more complicated form Tax loss/gain harvesting, and I am glad you see it as avoidance not evasion, a CPA's perspective is always appreciated :)

As is life anything can back fire, "The best laid plans of mice and men", but we can only plan for the foreseeable future, and I was just thinking about this in terms of a near term certainty, medical diagnosis in hand with a fairly health spouse etc... Clearly the healthy spouse could get hit by a bus visiting the hospital, but I think the family in question has bigger tragedy in the forefront then to worry about then taxes.... So all things being equal just looking at the financial question of planning for the foreseeable untimely medical death (sadly drawing from personal family experience).  So when ever a new twist develops I like to think of how to plan for it... Hoping all my useless planning is for nothing of course :)

So back to the finances... I guess in thinking about it further, the dying spouse could simply sell the losses and the surviving spouse would get to carry them forward since the joint tax returns would be filed for at least the year of death and then 1 to 2 years successive, that would give you at least that long to use up the losses... what happens to carry forward losses to a surviving spouse when they have to change their filing status to single eventually and there is losses from the join status still not used.

Now on to the other side of the question... Lets my grandparent or parent gifts me $14k of IBM at a capital loss because he has no use for losses they are retired and have the 0% cap gains tax rate, but I on the other hand am in the 25% to 39.6% tax bracket and have a 15% to 23.8% cap gains, since the IBM is not stepped up, I immediately sell the IBM take the loss against my income $3k and then either carry it forward or use it against capital gains I have for $11k.

No once again the 5 year claw back applies to estate tax if they are applicable to the $14k (or does that not apply to the annual gift limit and only gifts up applied to the estate tax lifetime gifting max?), but that has nothing to do with the capital gains/loss just the principal amount.

Thanks again for your insight Cheddar!

[Mister Fancypants]

I can see how this would work, and it probably done accidentally by many couples since the husband probably has the brokerage account and is typically the one that dies first (that's the way it'll probably be for me, and also likely tax law will change many times over, so I'll be sure to have my CPA by my death bed :)

I'm not sure it could work between generations (the grandparent example), when it comes to 'gifting a loss' / preserving a lower cost basis.  The gift (even of the stock certificate) would transfer at it's current FMvalue, right?  Best to let it transfer at the stepped-up basis (if appreciated) or take the loss (and offset gains so that carryover losses aren't, uh, lost)...  Could you explain your understanding on this one (since it is more likely to apply to me in the near future than the spouse one).  Maybe I can get those grandparents to gift us any losers they are hanging on to...

Gifts don't step up, they retain there cost basis, inheritances step-up.

[Mister Fancypants]

Keep a brokerage account for husband and wife. If one spouse is older/unhealthier you could put your more long-term buy and hold plays in that portfolio since they would achieve a step up upon death. The spouse you expect to live longer would hold the more aggressive short-term plays which could result in big losses to harvest more regularly.

Total forgot this point... My wife has a brokerage account worth several hundred thousand which has single stock gifts in it from her parents/grandparents for decades already, there is already hundreds of thousands of capital gains which we are concerned we will never be able to sell any of it due to our high tax bracket, I figure at some point I/she will have losses to offset some of it and that combine with a estate planning and family deaths got me to thinking about all of this.

[arebelspy]

I have no comment on the moral/ethical part of it, but just want to say: Wow. This is a really clever strategy.

Even if I wouldn't do it, I appreciate the cleverness.

[Mister Fancypants]

I have no comment on the moral/ethical part of it, but just want to say: Wow. This is a really clever strategy.

Even if I wouldn't do it, I appreciate the cleverness.

Thanks ARebelSpy, I always appreciate a complement like that from you :)

[EscapeVelocity2020]

Gifts don't step up, they retain there cost basis, inheritances step-up.

This is a tricky one, and I still disagree with what your OP states.

Also to take this a step further, a dying parent or grandparent can gift losses to children/grandchildren to preserve the cost basis rather than be stepped up, even if it is within the 5 year claw back for estate tax purposes if applicable, the capital loss would be lost in an inheritance with a step-up while preserved in a gift, the estate tax would exist either way if the death occurs within 5 years of the gift/inheritance.

Inherited stock can get a 'step down' (and step up, which is the main benefit), but if the grandparent gifts it before they keel over, then you either get the current value or the original cost basis, so I don't see the spousal transfer-of-cost-basis benefit for a grandparent gifting option... 

You determine a gifted stock's basis by doing the following:
- Find out the purchase price the original owner paid for the stock plus the cost of any commission.
- Find out what the sale price of the stock was at the close of business on the day the gift was made.
If the stock has gone down in value from the time the donor acquired it to the day of the gift, then the basis is the stock price on the day of the gift. If the stock has gone up, then the basis is the donor's original cost, including commission.
You will need to know these numbers should you eventually sell the stocks you receive. At that time, you will need to figure out if you should report a capital gain or a loss on your taxes. Advice from a certified public accountant or a personal financial planner can help you make the best decision as to when it is advantageous for you to sell.

The value of inherited stock, however, is usually based on the price it sold for on the day the original owner died. If the value is higher than what the stock was originally purchased for, then the basis is "stepped up." If lower, then it is "stepped down."
Incidentally, it is the donor who pays any taxes on a gift. The recipient of a gift, however, pays taxes on stock dividends and on capital gains. Likewise, heirs do not pay taxes on stocks they inherit. But they do pay taxes on dividends and on capital gains.

[Mister Fancypants]

You determine a gifted stock's basis by doing the following:
- Find out the purchase price the original owner paid for the stock plus the cost of any commission.
- Find out what the sale price of the stock was at the close of business on the day the gift was made.
If the stock has gone down in value from the time the donor acquired it to the day of the gift, then the basis is the stock price on the day of the gift. If the stock has gone up, then the basis is the donor's original cost, including commission.
You will need to know these numbers should you eventually sell the stocks you receive. At that time, you will need to figure out if you should report a capital gain or a loss on your taxes. Advice from a certified public accountant or a personal financial planner can help you make the best decision as to when it is advantageous for you to sell.

The value of inherited stock, however, is usually based on the price it sold for on the day the original owner died. If the value is higher than what the stock was originally purchased for, then the basis is "stepped up." If lower, then it is "stepped down."
Incidentally, it is the donor who pays any taxes on a gift. The recipient of a gift, however, pays taxes on stock dividends and on capital gains. Likewise, heirs do not pay taxes on stocks they inherit. But they do pay taxes on dividends and on capital gains.

Ok I see what you are saying I did a little more research... the grandparent/parent scenario won't work, you can't gift a loss, you have dual basis and depending on when you sell it is either a step-up basis or step-down basis.

Here is a good explanation http://fairmark.com/capgain/basis/gift.htm

As far as the spouse situation, you can easily transfer losses if or gains as gifts to shift the basis to prevent an inheritance step-up/down basis.

Here is a good explanation http://fairmark.com/capgain/basis/spouse.htm

[Mister Fancypants]

Another scenario...

This one is less morbid... but along the same line of thought...

Lets say a married couple is working and in the 25%+ federal tax bracket and has children that are fresh out of college who make substantially less then them who will be pay 0% capital gains tax.

Can the married couple gift appreciated assets to the children to the annual limit as a birthday gift, the children then the children sell the assets tax free. And the children gift there parents cash back to the same legal limit for their birthdays.

I mean in theory I send my parents a check for there birthday every year and they send me the same amount back every year for mine... its kinda the same thing except I give stock they give me cash.... The amounts are just higher...

Is that tax evasion?

A married couple with 2 adult married children in the 0% cap gains tax bracket have an annual gift limit of $112k, that's a lot of tax free capital gains.

[johnny847]

Another scenario...

This one is less morbid... but along the same line of thought...

Lets say a married couple is working and in the 25%+ federal tax bracket and has children that are fresh out of college who make substantially less then them who will be pay 0% capital gains tax.

Can the married couple gift appreciated assets to the children to the annual limit as a birthday gift, the children then the children sell the assets tax free. And the children gift there parents cash back to the same legal limit for their birthdays.

I mean in theory I send my parents a check for there birthday every year and they send me the same amount back every year for mine... its kinda the same thing except I give stock they give me cash.... The amounts are just higher...

Is that tax evasion?

A married couple with 2 adult married children in the 0% cap gains tax bracket have an annual gift limit of $112k, that's a lot of tax free capital gains.

This seems feasible to me, but I'm not quite sure where you're getting the $112k figure from. The amount of money one can gift without any taxes is $14k per donor-donee pair.
Also, if they were to gift that much money, depending on how much capital gains there are in the gifted funds, it could cause the adult married children to exceed the 0% capital gains bracket, depending on how much money they make on their own.

[Cheddar Stacker]

It's 14K per person, and he stated 2 adult married children.

Misterfancypants give the following:
$14K to daughter #1
$14K to daughter #2
$14K to son-in-law #1
$14K to son-in law #2

Mrsfancypants give the following:
$14K to daughter #1
$14K to daughter #2
$14K to son-in-law #1
$14K to son-in law #2

$112K total. All perfectly within the annual limits.

I'd be totally comfortable with you giving all those gifts. The kids giving cash back to you however just feels a bit icky. I'm not sure if it's legal, but it doesn't feel right.

[johnny847]

It's 14K per person, and he stated 2 adult married children.

Misterfancypants give the following:
$14K to daughter #1
$14K to daughter #2
$14K to son-in-law #1
$14K to son-in law #2

Mrsfancypants give the following:
$14K to daughter #1
$14K to daughter #2
$14K to son-in-law #1
$14K to son-in law #2

$112K total. All perfectly within the annual limits.

I'd be totally comfortable with you giving all those gifts. The kids giving cash back to you however just feels a bit icky. I'm not sure if it's legal, but it doesn't feel right.

Gotcha. Pretty sure it's legal.
It may not feel right to some, but I "launder" money through a 529 to get a tax deduction that for money that I would've spent on education anyway, so it would be hypocritical of me, at least, to view this move as unethical.

[secondcor521]

If it is a quid pro quo then the IRS will probably disallow the gift and require the taxes on the gains to be paid as though the stock were actually owned by the parents at the time of sale.  Even if there is never an off-the-record conversation between the parents and the next generation, if the amounts gifted back and forth are about the same, and the stock always happens to be sold by someone in a lower bracket, and if it goes on for several years.

Would their computers catch it?  I dunno.  But if anyone snitched on you or if you chance into an audit, you're probably out of luck.

They might also be able to impose interest and underpayment penalties.  They also, I believe, can go back as far as they want if they can prove tax evasion.

Read up on the substance over form doctrine.  Good link here:  http://www.taxprophet.com/archives/faq/faqjul06.html

Gifting capital loss stock from grandparents to grandkids (or grandparents to parents), as others have pointed out, the receiver's basis would be the FMV as of the date of the transfer, and the capital loss would go unused.

I live in a community property state so I was unaware of the gifting between spouses idea.  But I trust Fairmark's website.  That page doesn't spell out the rules for holding period in a sale between spouses, but I would guess that since you get the spouse's basis you also get the spouse's holding period.

The other thing I would worry about, though, is that Fairmark's page doesn't say what happens in the case where stock is inherited by the surviving spouse.  I did find this link (http://www.costbasis.com/stocks/iinheritedit.html) which at the bottom of the page says that in this kind of scenario, unless you do it a year ahead of time, you revert to the original (lower) basis - in other words, that AAPL stock reverts to the $100 basis.  Section 1014 of the IRS code, apparently.

Kudos for creative thinking, though.

[dragoncar]

Not a tax lawyer, so do your own research but tha is my understanding:

In community property states, hold the property as community property.  When spouse dies you get the step up basis without shenanigans.  Works really well for real estate.

Eg http://www.calcpa.org/content/consumers/ask/1999/11.03.aspx