The Kiddie Tax Revisited 9/2/07

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The Kiddie Tax Revisited 9/2/07

Stewart H. Welch III, CFP, AEP
Founder, The Welch Group, LLC

The Kiddie Tax Revisited

“The Kiddie Tax Revisited”


Tax planning is like a chess match between the taxpayer and the government.

Before 1986, one strategy often used by high tax bracket taxpayers to save on their taxes was to gift income oriented investments to children who were in a much lower tax bracket, thus ‘cheating’ the government out of much needed (wanted) revenue.  In an attempt to put a halt to this ‘loophole for the rich’, Congress passed the so-called ‘kiddie tax’, which taxed unearned income above certain modest thresholds at the parents’ highest marginal tax rate for children under the age of 14.

As a result, high tax bracket parents continued to use the old strategy once their children turned age 14. 

To counteract this, in 2006, Congress passed the “Tax Increase Prevention and Reconciliation Act”, which increased the effective age for the kiddie tax from 14 to 18.  Then, before the tax strategists could hatch a counter move, Congress made a preemptive strike…two moves in a row…’cheaters’!  In May of this year, Congress passed the “Small Business and Work Opportunity Tax Act of 2007”.  This act expands the kiddie tax age limit to include children under the age of 19 plus children who are full-time students under the age of 24 for the tax years beginning January 1, 2008 and after.

Bishop takes our Queen.  Now it’s our move.

Remember, not all income is affected by the “kiddie tax”.  The “kiddie tax” only applies to unearned income, not salary or wages earned by the child. The annual thresholds for 2007 are: the first $850 of a child’s unearned income is tax free and the next $850 is taxed at the child’s own tax rate. But any unearned income in excess of $1,700 in 2007 is taxed at the parents’ highest marginal tax rate.

Counter move #1.  If your college-bound child (or grandchild) will turn 18 (or older) this year and is in one of the two lowest tax brackets (10% or 15%), you can cut your long-term capital gains taxes by 10% by gifting long-term appreciated property to your child this year.  They then sell the property this year and pay the lower 5% long-term capital gains rate versus your 15% rate.  In order to create this savings, the transactions must be completed before year-end.  If you had planned on making gifts of appreciated stock to your college-bound children over the age of 18 in future years, you might consider making that gift this year since this ‘loop-hole’ ends this year.  An individual can give each recipient up to $12,000 a year ($24,000 for married couples) without triggering the gift tax.

Counter move #2.  If your child or grandchild is age 19 or older, not in college, and in a low tax bracket, you can still play the tax game as it was originally intended!

Counter move #3.  If your children are married and file a joint tax return, the kiddie tax does not apply no matter what their age. 

Counter move #4.  If your child is age 19-23 and provides more than 50% of his or her support, the kiddie tax does not apply.

Our pawn takes their Bishop.

Contact your CPA or financial advisor to determine if these strategies are appropriate for you.  My thanks to my associate, Michael Wagner, CPA, for his assistance with this article.