Question

20) 20. George, a high-bracket taxpayer, wishes to shift some of his own taxable income from corporate bonds he owns to his 25-year-old daughter, Debra, so that Debra rather than George is taxed on the interest. One alternative is to make a gift of the interest, and the other is to make a gift of the bonds themselves. Evaluate the pros and cons of each alternative.

Answer 1

Pros
A gift of the income only from the bonds is not effective for tax purposes.
Cons
To shift the gross income to Debra, George must give her the bonds themselves. Debra is old enough then to avoid the Kiddie Tax, and the income shift is tax effective if George’s marginal income tax rate exceeds Debra’s.

As you would know to qualify a gift as annual exclusion the gift should create a present interest

corporate bond has two components

a interest income and other is principal on maturity

The gift of interest income on corporate bonds qualifies as annual exclusion

gift of the remainder will be taxable on amount exceeding annual exclusion

So if the amount of interest income is above annual exclusion, the gift of the interest would be preferable because the annual exclusion would be used. In this situation, the interest from following years will also be considered a gift and may trigger tax consequences. The gift of the full principal amount of the bonds will have larger taxable gift amount equal fair market value of bonds minus annual exclusion. However the interest income will belong to Debra and will not be taxable income neither in the current nor in following years