Gift and Estate Tax Rules and the Series 7 Exam

By Steven M. Rice

Fortunately, you need to know only limited information on gift and estate tax rules for the Series 7 exam. Although some of your clients may receive a gift or inheritance of money, paintings, a car, a little red wagon, or whatever, you only need to be concerned with a gift or inheritance of securities.

Both gift taxes and estate taxes are progressive taxes (the higher the tax bracket, the higher the percentage of tax paid). Additionally, the recipient is never responsible for the taxes on the gift or inheritance. The main thing that you need to focus on is the recipient’s cost basis for the securities.

Gift taxes

A gift tax is a progressive tax imposed on the transfer of certain goods. In the event that a gift tax is due, it’s always paid by the donor, not the recipient. For example, if someone makes a gift to a minor in a Uniform Gift to Minors Act (UGMA) account, the donor of the gift, not the minor, is responsible for any taxes due.

The IRS does allow some gift-tax loopholes. Anyone can give a gift of up to $14,000 per person per year that’s free from the gift tax and up to $5.43 million over the course of the gift-giver’s lifetime. Gifts between spouses aren’t subject to gift taxes unless one of the spouses is a non-citizen.

To help determine capital gains or losses (see “At the sale: Capital gains and losses”), when a gift of securities is made, the recipient assumes the donor’s cost basis (purchase price of the security) as long as the securities have increased in value. If the securities decrease in value after the original purchase, the recipient assumes the cost basis of the securities on the date of the gift.

The following question tests your understanding of how the cost basis carries over with gifts of securities.

  1. Mary Johnson purchases 100 shares of LLL common stock at a price of $60 per share. She gives the securities to her son Zed when the market price is $75 per share. What is Zed’s cost basis per share?

    (A) $60 per share

    (B) $67.50 per share

    (C) $75 per share

    (D) It depends on the holding period

    The correct answer is Choice (A). Because LLL increased in value after the original purchase, Zed assumes his mother’s cost basis.

    This next question concerns the cost basis of a gift when the market price of the stock falls.

  2. John Johnson purchased 1,000 shares of DIM Corp. common stock at $40 per share. DIM subsequently decreased in price to $30 per share, and John gave the securities to his father-in-law, Mike. Two years later, Mike sold the stock for $37 per share. What is Mike’s tax situation regarding the sale of the DIM stock?

    (A) $30,000

    (B) $35,000

    (C) $37,000

    (D) $40,000

    The right answer is Choice (A). Because DIM decreased from the original purchase price, Mike assumes the cost basis of the DIM stock on the date of the gift, which was $30,000 (1,000 shares x $30).

You’re more likely to get a Series 7 question about a security that increases in value before it’s given as a gift.

Estate taxes

Estate tax is a tax on property that is passed along to someone’s estate when the person dies. Inheriting securities is a little more straightforward than receiving gifts of securities. When an individual receives securities as a result of an inheritance, he always assumes the cost basis of the securities on the date of the owner’s death. Additionally, securities received by inheritance are always taxed as long-term.

When a person dies, estate taxes are normally paid before assets are transferred to beneficiaries. Because the estate pays the taxes on the securities, the tax liabilities aren’t passed along to the beneficiaries. As of 2015, the filing of an estate tax return is required only for estates that involve the transfer of $5.43 million or more.

Presently there is a unification of gift and estate taxes rule that says a giver cannot give more than $5.43 million in gifts over his lifetime, including assets to beneficiaries upon death, without his estate being subject to additional taxes.