Our son (and future college grad) is 6 months old. Your opinion, please, on saving/investing for future college expenses. Are zero coupon bonds still a safe and logical bet? How about annuities? Or should we just make deposits monthly into a savings account?
Zero coupon bonds look good -- buy corporates until the projected annual income reaches $1,000, then go for municipals. (That's because unearned income over $1,000 a year is taxed to the child at the parent's rate until the child reaches the age of 14.) Find zeroes that mature just before you expect to need them so you can count on the face value; before maturity, market values experience greater fluctuation than regular issue bonds.
Annuities are good, too, because the annual income is untaxed until withdrawn, presumably when the child is older than 14, and the proceeds will be taxed at the child's rate. There's another option you didn't mention: I would be inclined to put at least a part of your monthly college savings into a growth stock mutual fund. With some 17 years for the money to grow, I think a high quality fund that specializes in growth investments will end up with the best return. While a growth fund will probably throw off some taxable income in the form of annual capital gains, this will be minimal and could be sheltered under the $1,000 umbrella for a young child. Drop me a line in 17 years and let me know how it worked out.
A few years ago, I bought some stock in a new bank. Recently, I received a 5 percent stock dividend. I called the bank to ask about the value of the dividend for tax purposes, and was told that a stock dividend was not taxable until sold. Is this correct? IRS instructions say dividends, either cash or stock, must be reported as income. I did get a cash-value basis, because I know when the dividend shares are sold I will have (hopefully) a capital gain.
The bank is correct -- a stock dividend is not reportable as income for tax purposes. When the IRS talks about reporting dividends, whether received in cash or stock, they are referring to cash dividends that the taxpayer elects to have reinvested in additional stock through a company dividend reinvestment plan in lieu of taking the cash. You can forget about the cash-value basis you mentioned. The number of shares you received as a stock dividend is added to the initial amount; then the original cost is divided by the new total shares owned to give you a new per-share basis, which is used when you sell any of the shares -- either the original or the dividend shares.
Example: You buy 100 shares of the XYZ bank at a cost of $2,000, or $20 a share. On receipt of a 5 percent stock dividend, you have a total of 105 shares. The $2,000 cost is now divided by 105 to give you a new per-share basis of $19.05. If you later sell any five shares, your basis for calculating capital gain is five times $19.05, or $95.25.
In your June 15 column, you answered a question about qualifying for the $125,000 exclusion on sale of a home from a couple who had become Florida residents and were now selling their northern home. You said they had to have owned and occupied the property as their principal residence for at least three of the five years preceding the sale. What would your answer be for a taxpayer who was visiting relatives in California six years ago when she became ill? She has not been able to return to her home on the East Coast since, but has maintained it as her residence with the intent of returning when physically able to do so. She doesn't own any property in California. If she decided now to sell her residence on the East Coast, would she qualify for the $125,000 tax exclusion?
Yes -- assuming, of course, that she meets the over-55 age requirement. Temporary absence because of illness doesn't change the character of her home on the East Coast. If she maintained the home, as you wrote, and intended to return, it remained her principal residence. Six years is a long "temporary" absence, but her intent to return when able to do so qualifies the home as her principal residence, making her eligible for the $125,000 exclusion of gain.
Abramson is a family financial counselor and tax adviser. Questions on tax matters, insurance, investments and estate planning will be answered in this column. Advice cannot be given on an individual basis. Address questions to E.M. Abramson, The Washington Post, Business News, 1150 15th St. NW, Washington, D.C. 20071.