Tax Tip: Be Aware of the Kiddie Tax

Posted on 04. Dec, 2006 by in Taxes

kiddie_tax.jpgAs you know, the best way to decrease your tax bill come April is to “stash” as much of your income into tax-free vehicles. For some that means retirement accounts, and for others it means giving it away… to you kids.

Before the “Kiddie Tax” was implemented, wealthier families would “stash” some of their income into investments in the name of their children so that when their child earned a few thousand dollars in interest, it would be taxed at the child’s tax rate and not at the parents’. Well, Uncle Sam got wise of the whole situation – like he always does – and enacted the Kiddie Tax. The Kiddie Tax has allowed parents to continue this practice or investing in the name of a child, but Uncle Sam has put a rather harsh cap on the amount of income can be taxed at the child’s lower tax rate. And to make matters worse (it depends on who you’re asking), the IRS has increased the age of children who qualify for the Kiddie Tax to 18. This means the IRS will be able to collect taxes on investment earnings by older children (up to 18yrs old) based on their parents’ tax rates.

This is how it works now. The first $850 of a child’s investment income now remains tax-free as before (at the previous $800 level in 2005), and the next $850 is taxed at the child’s lower rate. But if the child is younger than 18, instead of 14 as before, the kiddie tax will kick in. This means families who might want to set aside assets that generate more than $1,700 in income in a child’s name so it would be taxed less no longer have that option.

So why is Uncle Sam taking this cheap shot at children?

Because government accountants estimate the law change will raise $2.1 billion in taxes over the next 10 years, mostly from upper-income families. And since congress is SLOWLY trying to fix the AMT disaster, the government is going to be finding itself short a few billion dollars soon.

More details on filing requirements for children can be found in IRS Publication 929, Tax Rules for Children and Dependents. The current edition reflects 2005 filing law, but an updated version has not been published yet.

However, please be aware of the new rules surrounding the Kiddie Tax. And if you’re not taking advantage of this tax break, you might want to consider starting a little investment for your child. It would be a great opportunity to learn more about money with your child, and you could work together to research and follow your investment.

2 Responses to “Tax Tip: Be Aware of the Kiddie Tax”

  1. John W

    08. Jan, 2007

    Good to know.
    I tend to think that the IRS estimates might be a little high. Something tells me that once the tax accountants for the folks using this tax-free vehicle are aware of this they’d likely move the investments to another vehicle.
    If they aren’t aware of it, they certainly wont make the same mistake next year.


  1. The New Kiddie Tax Continues to Punish Parents at - June 7, 2007

    […] I’ve spoken about the Kiddie Tax before and how it was initially established to help prevent wealthier parents from “stashing” cash and assets in the names of their kids so that they could avoid higher tax brackets. […]

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