Stock appreciation/taxation

[Belgarath]

A lady who works with me asked me a question about gains on stock that was gifted to her originally. This is a non-pension issue, and I have absolutely no knowledge in this area. So I told her I'd post her question, to see if any of the experts here can either provide some feedback, or provide some reference sources? Thanks in advance for any feedback! Here's her question:

Situation:

366 shares of bank stock were gifted to me in the early 1980's. Value was approximately $8000. Dividends have been paid in cash so they did not purchase additional shares. I have not redeemed any shares since I have owned it. This stock has split twice so I now own 1464 shares. Value is now approximately $45000.

This bank has been bought by another so I need to turn in my current certificates so I can be issued stock on the new bank.

Questions:

The stock was originally owned by a grandparent but I do not recall if it was gifted to me directly from the grandparent or if it went to a parent then to me. Do I need to know from which generation the stock was gifted?

For 2004 tax purposes, will the sale of the stock of the original bank all be reported as a capital gain?

If so, what info do I need to determine my basis? How do I obtain that info? I have possesion of all of the certificates but no additional information.

Is it to my advantage to convert the stock to the new bank stock or would it be the same tax treatment as selling the stock?

I had not planned on selling all of this stock in one calendar year as I don't want to increase my taxable income by more than $10000 in any one year.

When selling stock that has been split, how is the basis determined? Is it a different method if selling all at once than if selling a portion?

Advice welcome. thanks

[401 Chaos]

I am far from an expert in this area and would advise the individual to talk to an accountant or other tax professional regarding the facts of her particular situaiton but some general thoughts are as follows:

As a general matter, recipients of gifted stock get a "carryover basis" meaning they take whatever cost basis the original owner had in the shares rather than the FMV on the date of gift. Obviously establishing carryover basis can be a challenge without careful records dating back to original purchase. Hopefully this is not an issue here. Also, given the small initial amounts involved here, it does not sound as if there should have been any gift tax issues for the original donors and, even if there were, that generally shouldn't be an issue for your friend nor should it matter what generation actually transferred the gift. (Note, the general rule envisions that each tranfer or sale is at a gain. The basis amount is different if the grandparents gifted the stock at a time when the FMV was less than the amount they originally paid.)

A more significant question is whether the stock was inherited by any party rather than gifted. If so, the recipient is generally entitled to a "stepped-up basis" (i.e., basis equal to the FMV of the stock on date of death) rather than a carryover basis. This could be a significant break to your friend if say the stock passed from grandparents to parents by death and then parents immediately "gifted" the shares to your friend.

Does your friend want / need to sale the stock now or is the potential sale all being raised as a result of the change in control of the bank? Obviously we don't know anything about the specifics of the transaction but generally such sales are structured so as to be tax-free or not to have tax impact on shareholders. The certificates would have to be redeemed for new certificates but she should be free to hold the stock without paying capital gains until some later disposition if she desires. Obviously the basis amounts gets jumbled a bit more as a result of the conversion of the shares but the real question I think is whether she thinks this new stock is a sound investment and wants to hold it or if she thinks the value may have peaked. There is usually a fair bit of information regarding the conversion formula and basis calculations included in the information provided to shareholders in such sales. At any rate, I do not think switching the old shares for shares in the new company should have the same tax affects as selling the shares.

As for adjusting basis for stock splits, you generally reduce the original basis for each split fraction--for example, if a split is 2 for 1, you would get twice as many shares but your basis in each share would be 1/2 of the original. In short, the overall total basis amount is the same but the individual per share basis amount must be reducted to reflect the increase in number of shares.

[E as in ERISA]

If she does dispose of any of the shares, she will get a tax reporting stating what the proceeds are ($45,000) not the amount of the gain. It will be up to her to figure out what the "cost" is and subtract that before reporting the gain.

[Belgarath]

Thanks! I'l pass this along to her.

[mbozek]

I dont understand why the client wants to limit the sale of stock so as to not increase taxable income by more than 10k a year since long term capital gains are taxed at either a rate of 5% or 15% of the gain. If the gain is 40k the max captial gains tax will be 6k. Delaying the stock sale to limit taxes could backfire if the price of the stock takes a significant hit. Also the capital gains tax can be reduced by selling oyther stock for which there is a tax loss.

What the client needs to do is reconstruct the tax basis for the stock remembering that the donee of a gift of stock takes the donor's basis and the recipient of stick inherited at death has a basis in stock at the fmv on the date of death.

You also need to review the conditions of the change in ownership. Usually an exchange of stock of one co for another co is not a taxable event.