New Year, new tax laws.

And what's this..???   A break ???

When was the last time you heard of a really terrific scheme for saving on income taxes and helping your family at the same time?  

I can think of a few fairly new features of the income tax law that fit this bill: the child tax credit, the Hope Scholarship credit, and the lifetime learning credit. These benefits all fit into the category of you don't have to do anything you wouldn't have done anyway and you still get a tax benefit.  

One major drawback to the aforementioned credits is that they are only available for low to middle income taxpayers. Many families, especially those with multiple incomes, exceed the income ceiling for these credits and therefore don't benefit from these features.  

Now we have a new twist in the tax law, one that is friendly to families with enough extra income that they have been able to invest money in stocks and mutual funds with the plan of using that money to pay for their children's college education.  

You may have read about the changes in the tax law that became effective January 1, 2001 regarding the tax on long-term capital gains. The new capital gains tax rate has dropped to a maximum of 18% for gains on investments held for more than five years, if your normal tax bracket is 28% or higher. The catch in claiming this new low rate, however is that it only applies to stocks acquired in 2001 or later and held for five or more years.  

Taxpayers whose normal tax rate is 15% are entitled to a special capital gains tax rate of 8% on gains from sales of investments held for more than five years. The holding period on these investments doesn't have to begin in 2001 or later - the new 8% rate is effective now for any stocks or similar assets sold on or after January 1, 2001, as long as they have been held for five years.  

Here's the beauty of this new law: A taxpayer in a higher tax bracket, who has been holding stocks for five or more years, and who decides to sell those stocks in 2001, would normally not be entitled to the 18% special rate on capital gains, and would certainly never qualify for the new 8% rate.  

But make a gift of those stocks to someone in the 15% bracket - your child who is about to go to college, for example - and your holding period of five or more years transfers to the recipient, along with the right to sell the stocks immediately and claim the low 8% tax rate on the long-term capital gain.  

Make sure the recipient is at least 14 years old - children under age 14 pay tax at their parents' tax rate. And keep in mind the fact that gifts of over $10,000 per year are subject to a gift tax, payable by the person making the gift.  

Also, if the IRS examines the tax returns in a situation like this, they will want to ensure that a true gift was made. You can't simply put the stock in the child's name for the purpose of getting the lower tax rate on the stock sale, and then take the proceeds of the sale yourself. The money from the sale of the stock must rightfully belong to the person who received the gift.

That's why this is such a great vehicle for families with college-age children. If you have the money for your child's college costs stashed in the stock market, and you plan to use that money for the child anyway, go ahead and gift the stocks to the child before you cash them out, and the money saved on the taxes may ease some of the burden of the college costs.