Means Higher Taxes
ago, Congress came up with the concept known as the Kiddie
Tax. It was intended to discourage high-tax-bracket parents
and grandparents from shifting taxable income (especially from
children in order to reduce the family's income tax bill.
Gains May Not Be Possible,
But if You Act Fast,
Your Family Might Be Able to Pay Just 5 Percent
Based on tax rules that are
scheduled to kick in next year, some parents and
grandparents in high tax brackets were planning to give
older teens appreciated assets they had held for more
than a year.
The youngsters could
then sell the assets in 2008 and pay no federal capital
gains tax, while their higher bracket parents and
grandparents would have to pay 15 percent. That's
because the capital gains rate will drop to zero percent
in 2008 for taxpayers in the lowest two tax
Unfortunately, the new
law passed last month has eliminated that opportunity in
many cases under new Kiddie Tax provisions that become
effective in 2008.
So if you act
fast, there still might be a way to pay only the current
5 percent capital gains tax on gifts to children who
will be age 18 and older on
You can give each of
them up to $12,000 worth of appreciated securities this
year without any gift or estate tax consequences. If
you're married, your spouse can give away $12,000 to
each child too.
can then sell the appreciated securities before the end
of 2007 and pay only 5 percent capital gains tax, if
they are in the 10 or 15 percent tax brackets. The sales
proceeds can be used to cover college or other expenses.
For this to work, however, you and the gift recipient
must have a combined ownership period of more than one
All Income is
The Kiddie Tax Only Hits Unearned
Income, typically from investments held in the
child's name. Earned income from jobs or
self-employment is exempt from the Kiddie
It Only Hits Unearned Income above an
Annual Threshold. For 2008, the amount will be
at least $1,700. It may be higher due to an inflation
Since its inception, many affluent families planned to
save money in ways to avoid the Kiddie Tax. Unfortunately,
Congress has pulled the rug out from under these families.
Under a new law, the Kiddie Tax will soon apply to older
children -- in fact, to young adults.
In this article,
we'll explain the current rules and how they will change under
the Small Business and Work Opportunity Tax Act of
2007, which was signed into law on May 25th.
The Basics. Let's say you're in the 35
percent federal tax bracket and want to shift assets to your
children or grandchildren. You figure they can invest in
income-producing investments like dividend-paying stocks,
T-Bills and mutual fund shares. Then, the kids could pay taxes
on the resulting investment income at a much lower federal tax
rates. Sadly, the Kiddie Tax rules are intended to stymie this
Child's Age Is the Key
In just over a year, Congress has changed the Kiddie Tax
rules twice. Here is a rundown of the situation:
- Before 2006, the Kiddie Tax only applied to years when
the child was under age 14 at the end of the year.
- For tax years 2006 and 2007, the Tax Increase
Prevention and Reconciliation Act (enacted in 2006)
changed the age to 18. So if your child is age 18 or older
at the end of this year, the Kiddie Tax does not apply for
- For tax years beginning in 2008 and beyond (for
calendar-year individuals), the Small Business and Work
Opportunity Tax Act changed the age again. In these
years, the Kiddie Tax can potentially come into play until
the year during which your child turns 24. In other words,
only when the child is 24 or older at year end can you say
with certainty that the Kiddie Tax will not apply for 2008
and subsequent years.
If your child is under age 18 as of the end of 2007,
some of his or her unearned income from investments might be
taxed at your higher marginal federal rate. The Kiddie Tax is
an issue for 2007 (and 2006) only when all of the following
requirements are met:
Requirement 1: One or both of the child's
parents are alive at year end and in a higher marginal
federal income tax bracket than the child.
Requirement 2: The child doesn't file a joint tax
return for the year.
Requirement 3: The child's unearned income for the
year exceeds the threshold for the year. The threshold for
2007 (and 2006) is $1,700. If the threshold is not exceeded,
the Kiddie Tax simply doesn't apply for that year. If the
threshold is exceeded, only unearned income in excess of the
threshold amount is hit with the Kiddie Tax.
Requirement 4: The child has not reached age 18 at
year end (in other words, he is age 17 or younger on
As you can see, the Kiddie Tax rules do not take into
account whether or not the child is claimed as a dependent by
a parent or by someone else.
Example: Let's say your son will be
age 17 on 12/31/07. For 2007, he is subject to the Kiddie tax
if all of the other three requirements are also met for the
year. Your daughter will be age 18 on 12/31/07. For 2007, she
is exempt from the Kiddie Tax because she reaches the magic
age of 18 by year end.
But what about 2008 and beyond?
Good question, because the stricter rules apply for those
How Your Family Could
Be Affected Next Year
For 2008 and later years, the Kiddie Tax is an issue when
certain requirements are met. As in the past, one or both of
the child's parents must be alive at year end and in a higher
marginal federal tax bracket than the child.
Tax still does not apply to a married child who files a joint
return. And a child can still earn taxable investment income
up to an inflation-adjusted threshold for the year (currently
$1,700) without being taxed at the parent's rate.
Here's what changed under the new law: The
Kiddie Tax may now apply depending on your child's age, status
as a student, and earned income. Unfortunately, the new rules
are complicated. In fact, there are actually three Kiddie Tax
rules that apply if the other requirements are met:
Rule 1 - If your
child has not reached age 18 at year end (in other words, he
or she is age 17 or younger on December 31).
Rule 2 - If your child
is age 18 at the end of 2008, and he or she doesn't have
earned income that exceeds half of his or her
Rule 3 - If
your child is age 19 through 23 at year end, is a student
and doesn't have earned income that exceeds half of
his or her support. A child is generally considered a
student if he or she attends school full-time for at least
five months during the year.
It does not matter whether a child in the above categories
is claimed as a dependent on a tax return. And in the case of
students, support does not include amounts received as
Other options: The new
law makes Section 529 college savings plans and Coverdell
Education Savings Accounts more attractive because investments
in them are not subject to Kiddie Tax. Consult with your tax
adviser for more information about how to proceed in your
situation. Call Ronald J. Cappuccio, J.D.,
LL.M.(Tax) Counsellor at Law at (856)