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| The New Kiddie Tax |
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Not having a lobby in Congress, a child, for tax purposes, is now anyone under 18 years old, instead of 14. This means that the under 18 year old will now have his investment income taxed at the parents’ rate, which is usually higher than the child’s.
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Prior to 1986, parents’ were putting bank, brokerage, and other investment accounts under the names of their children. This was a smart tax move because the child was in a lower, 10 or 15 percent tax bracket, whereas the parent was in the higher, up to 35 percent, tax bracket. The ‘Kiddie tax’ was then created to limit the parents’ tax savings.
The change in law still allows for savings, but not as much. As of January 1, 2006, the first $850 of unearned income, like from investments like savings accounts, stocks, and bonds, is still not taxed. Further, the next $850 is still taxed at the lower child’s income tax rate. The change is that now, any additional earnings, up to the age of 18, instead of 14, will be taxed at the parents’ rate. Although this did not become law until May 17, it is retroactive to January 1.
The estimate is that this change will raise $2.1 billion over the next ten years, mainly from upper-income taxpayers.
So what are your options?
1. If your child has savings accounts or Certificates of Deposit, consider putting the money into stocks that produce long-term capital gains as these are taxed at 15 percent instead of the higher, ordinary income rates. (Please consider ‘college planning’ because money in a child’s name is counted as the child’s asset and therefore will reduce financial aid.)
2. Consider the 529 College savings plan where the earnings grow tax-free. (For NY State residents, contributions are deductible on the State return.)
3. If you own a business, hire your child. Not only can you deduct the child’s salary, but the income is still taxed at your child’s rate. (If your business in unincorporated, there’s no social security tax required.)
4. Depending upon the amount your child earns, open a traditional, deductible, IRA to reduce the taxable amount. The earnings grows tax-free, and the principle is available for college – taxed when withdrawn, but with no withdrawal penalty.
5. Instead of a traditional IRA, consider a Roth IRA. Again, the earnings grow tax-free, and the principle is available for college – with no tax!
6. If you don’t own a business, hire your child to do housework, lawn care, etc. With that money, open an IRA. (See item 4 and 5 above.)
7. When you child turns 18, you can gift them appreciate stock (stock worth more now than when you bought it) which they can sell and be taxed at their lower rate. This may allow them to claim educational credits and deductions for which your income disqualifies you.
Also note, any income a child earns from working is taxed at the child’s rate, not the parents.
There are possibilities and pitfalls with the new law. I suggest strongly that you see your tax preparer as soon as possible to plan a strategy.
Questions? Contact Joseph Reisman at 2751 Coney Island Avenue, Brooklyn, NY 11235-5004
Tel: 718-332-1040; Fax: 718-743-2721; E-mail: JSReisman@TaxHelp1040.com.
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Posted on Jul 09, 2006 20:18pm by JSREISMAN
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