Life is uncertain and unpredictable, but death and taxes are inevitable — right? That’s what we’ve been told, anyway.
As it turns out, there are unique ways to avoid taxes legally. You just might not like what it takes.
Read More: What Is the Death Tax?
Startups and Charitable Donations
I’ve worked at several startups, and the first time one of my startups did well, I had some sizable stock gains. Everything looked good on paper, but the second I exercised those options to lock in the gains, I was going to owe significant capital gains taxes (not millions of dollars, but definitely a few zeroes).
For those of you who might not know how stock options at a startup work, when you join the company, they give you options to buy shares at the then-current price (say, 50 cents per share). Later, if the company is doing well, you can “exercise” those options and buy the shares for your grant price (50 cents each, in this example). If the stock is now worth $100 per share, you can then turn around and sell your shares for a healthy profit of $99.50 per share. Unfortunately, this does not escape the notice of various government tax agencies (federal and state) who might want a sizable chunk of that profit. You could end up owing 50 percent of that profit back to the government.
More on Getting in on the Ground Floor: What $1,000 in Stocks Invested 10 Years Ago Would Be Worth Today
There are some complexities here about buy-and-hold strategies, short-term versus long-term investments and options versus restricted stock that I won’t get into. But, the bottom line is that when you end holding some stock that has appreciated, you’re sitting on a nice potential profit … and so is the government.
Around the time that I was starting to enjoy my first financial prosperity, I noticed that my local school was constantly fundraising: for books, buses, supplemental teacher salaries — you name it. I realized that if, instead of donating cash to the school, I could donate my appreciated stock to the school’s fundraising charity, I wouldn’t actually be “selling” the stock. Consequently, I wouldn’t be subject to the capital gains tax, and I’d get a charitable tax deduction for the full appreciated amount. And the school would get the donation at face value, so they wouldn’t owe any capital gains taxes when they sold the shares, either. Everyone would win (except, of course, the tax agencies).
It turns out it is possible to avoid capital gains taxes permanently. And this works with any appreciated asset, not just startup stock. But to take advantage of this strategy, you have to give away the appreciated item to a qualified charity. If you’re of a generous frame of mind, this works out well. But, if you’re trying to optimize your wealth, this strategy has some admitted issues.
Death, Taxes and the Magical “Step-Up”
Another way to achieve 0 percent taxes is to die (yikes!) and bequeath your appreciated asset to someone or some organization. The recipient will enjoy what’s known as a “step-up” in cost basis, so that when they sell the asset, they only have to pay taxes on any gains since your death. There are some exceptions to this “step-up,” but if the estate executor is using EstateExec to settle the estate, it will automatically make these cost basis calculations so the heirs understand their tax situations, which can be very helpful.
Discover: How to Minimize Your Estate Tax
What this means is that if you have an asset that has appreciated enormously, and you don’t need to sell it, it might be best to simply pass it along to your heirs and skip the capital gains tax — entirely and forever. Now that’s certainly on the list of helpful tax loopholes, except you have to die to use it or be on the receiving end.
When a relative passed away and I inherited some stock, I was able to take stock that had appreciated more than 100 percent from its original purchase and sell it for a small loss (on paper). That’s tax-advantaged. All the money from the sale was tax-free, and I got to write off a small loss on my taxes. The moral here is to pay attention to cost basis when receiving an inheritance and maybe talk to someone from whom you expect to inherit about these implications (i.e., don’t liquidate the portfolio immediately before death, just to “make things easy”).
You still can’t escape death, but at least some of your assets can escape taxation.
Read More: States With Inheritance Tax
More From Our Smart Money Squad
- Being the Executor of His Dad’s Estate Inspired This Man’s Business
- The One Thing I Wish My Father Had Done
- The Truth I Told a Friend About Death and Debt
- Watch: How to Legally Cheat Your Tax Bracket
We make money easy. Get weekly email updates, including expert advice to help you Live Richer™.