Shift to Save

Example #2: A student’s college expenses are $30,000 per year

The parents may earn $45,000 to cover the $30,000 cost while also facing income taxes of $15,000, or they may sell an asset worth $20,000 that has appreciated in a 15% long-term capital gain bracket. As in the first example, with a $20,000 capital gain there would be $3,000 due in taxes. To pay the remaining $13,000 in educational costs would require earning approximately $20,000. The family would accumulate $30,000 for their child’s education that year, but with a tax cost of $10,000.

But what if they paid the child $20,000 in wages for work such as a consultant or proofreader during the summer and on some school breaks, and gifted the appreciated asset to be sold in the child’s tax bracket? In that case, tax would be approximately $1,500 based on an adjusted gross income of $12,000, after the student uses the personal exemption of $3,100 and standard deduction of $4,850. The rationale for this action is discussed in the article. Since the child is not a dependent, he may then use a Hope or Lifetime Learning Credit to wipe out most of the $2,500 in tax liability for the student ($1,000 capital gains and $1,500 tax on earned income after deductions).

By using income shifting, you have saved your client between $7,500 and $10,250 in one year.