Can I Put My Child's Capital Gains to Work for Me?

The Tax Forum is addressing some kiddie tax issues this week. It's amazing how complicated your child's $1,000 in interest can be. We're also calculating the cost basis for investments in an IRA, and we've got a list of investment-related deductions for investors.

Please send any other questions you may have to [e-mail]. And don't forget to include your full name.

Credit Card Follow-Up

A few weeks ago, we wrote about how you now can use your MasterCard, American Express or Discover credit cards to pay your 1998 tax bill. And, in the end, I did not think it was a very economical idea. But reader Stan Brener, a bankruptcy attorney in New York, brought this point to my attention:

"Paying by credit card could help avoid a tax lien that would arise if you don't pay. Even if you default on your credit card bill, you generally get to keep your exempt property (in New York, this includes IRAs, and in Florida, your house). If you don't pay tax to the Internal Revenue Service, the federal tax lien can cause you to be stripped of virtually all of your assets."

OK. So maybe there is one reason somebody might want to use a credit card this tax season.

Putting Kids' Gains to Work

For 1998, my 7-year-old son had $4,000 in long-term capital gains from his mutual fund and another $1,200 in dividends. I had more than $10,000 in capital losses for the year. Since my son's income in excess of $1,400 or so must be reported at my tax rate, how do I make sure that I get the benefit of offsetting my son's capital gains against my capital losses?

-- Barry Lieberman

Barry,

If that $4,000 in capital gains had resulted from the buying or selling of shares, your child would need to file his own tax return, says Rande Spiegelman, personal financial services manager at KPMG. That gain would be considered earned income, so it would require a separate return. The bigger reason for filing a separate return: The IRS wants to prevent you from intentionally generating a gain or loss in your child's account just to put yourself in a better position.

But any unearned income can be reported on your return. So I am going to assume that the $4,000 in long-term capital gains was a distribution from your son's mutual fund. Since those distributions, along with interest and dividends, are considered unearned income, you can report those amounts on your tax return.

In this case, you need to file Form 8814 - Parents' Election to Report Child's Interest and Dividends. There may be instances where you can use your child's gains to offset your losses, notes Clarence Kehoe, partner and director of employee benefits at Anchin, Block & Anchin.

Check out Publication 929 - Tax Rules for Children and Dependents. There is a worksheet on page 7 of the publication that will help you determine how much of your child's capital gains can be reported on your Schedule D - Capital Gains and Losses. You will report the portion of your child's gains that qualify on line 13 of Schedule D, and you must write "from Form 8814" on that same line.

And here is a quick synopsis of your child's tax rates: The first $700 in income is not taxed; the next $700 is taxed at 15%. Any amount above that $1,400 will be taxed at your rate.

So to take advantage of these rates, try to give at least $1,400 in income to your child, suggests Kehoe.

What's the Cost Basis in My IRA?

Let's say I bought 100 shares of XYZ at $10 in a self-directed IRA. I have reached age 70 and must start taking distributions. I decide to transfer my 100 XYZ shares from the IRA account to a second, regular account with the same broker as part of this year's distribution. On the date of transfer, XYZ sells for $8. Three months later, when I sell the XYZ from my regular account, the price is $6.

In reporting this transaction on Schedule D, what do I use as the purchase price? The $10 that it cost me in the IRA account? Or the $8 market price on the effective date of the transfer from the IRA account to the regular account?

-- Lee Hyndman

Lee,

Assuming you never made any nondeductible contributions to your IRA account, the day of your required minimum distribution will be the day you use to determine the cost basis in the stock, says Natalie Choate, estate-planning attorney in Boston and author of Life and Death Planning for Retirement Benefits. So, in your case, the cost basis would be $8.

And remember, when you take the distribution from your IRA account, you are required to pay income tax on the money.

An Investor's List of Deductions

I would like to know what items can be deducted by the average investor with a day job who does not have trader status. For instance, if The Wall Street Journal can be deducted, can I deduct TheStreet.com and other Internet services and publications?

-- Scott Matthews

Scott,

Investors can deduct practically the same investment-related expenses as traders, says Ted Tesser, a CPA in Boca Raton, Fla., and author of The Trader's Tax Survival Guide. The big difference, as you know by now, is that traders can deduct 100% of their trading expenses while investors' expenses are itemized deductions, and only the amount above 2% of adjusted gross income is deductible.

One notable distinction is that traders can deduct the cost of investment seminars while investors cannot, says Tesser.

Otherwise, any expenses incurred in managing and conserving your investments are deductible. Note that the expense must be "reasonable in amount and must be closely related to the production or collection of taxable income, or to the management, conservation or maintenance of property held for the production of income," according to the Research Institute of America.

That means if you use TSC or the Wall Street Journal to make investment decisions, deduct away. Technically, though, if you sometimes read the Journal or, say, The New York Times for pleasure, you should only deduct the portion of the cost that pertains to your investment activities. Other deductible items, according to Tesser:

• Accounting fees
  
• Books and tapes on investing
  
• Calculators or adding machines
  
• Costs of collecting interest and dividends
  
• Tax advice
  
• Home computers and software
  
• Data-retrieval services
  
• Interest expenses
  
• Legal fees
  
• Subscriptions

A stock investor also can deduct taxi fares for weekly visits to a custodial bank and monthly consultation visits to a stockbroker, according to RIA.

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