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Dealing With Kiddie Tax Rules
One step: Keep child's investment income less than $1,900 this year. The kiddie tax was created in 1986 to keep parents from sheltering income by putting accounts in the names of their lower-taxed kids. In its original form, a portion of investment earnings held by a child were tax-free. Another portion of earnings were taxed at the youngster's tax rate. Any amounts over that second earnings threshold were taxed at the parent's highest marginal tax rate, which could be as high as 35 percent. Relief arrived once the child turned 14, and the excess earnings were again taxed at the child's lower rate. Upping the age and the ante On May 17, 2006, however, the kiddie tax effectively grew up. On that day, the Tax Increase Prevention and Reconciliation Act took effect with a provision to keep the parents' tax rates in effect until the youngster turns 18. But the readjusting of the age limit didn't end there. Thanks to the Small Business and Work Opportunity Tax Act of 2007, the kiddie-tax age limit was increased once again. For tax year 2008 and beyond, a young investor now must be 19 to take advantage of his or her own potentially lower tax rates. Even after the youth turns 19, the kiddie tax still applies to his or her investments if he or she is between ages 19 and 23 and a full-time student. All this kiddie tax tweaking means that by the time a young investment account holder can take advantage of his or her lower tax bracket, he or she will likely be out of high school and possibly earning enough at a part-time or full-time job to no longer be in the lowest tax bracket. Two-tiered structure remains The age changed, but the basic dual-tax structure for children's investment accounts remained the same. Children can still receive a portion of unearned income tax-free. For 2009 returns, the limit is $950, meaning that a child doesn't have to pay taxes on any interest, dividends or capital gains up to this amount. The child does have to pay taxes on the next $950, but at his or her lower tax rate. Once those 2009 earnings exceed $1,900, however, the preferential treatment ends. The earnings on those excess earnings are taxed at the parent's top marginal tax rate, rather than at the usual 15 percent capital gains rate. For 2009 tax-planning purposes, a child's allowable investment income amount goes up to $1,900, with the first $950 in earnings exempt but the next $950 taxed at the child's rate. Choosing whether child or parent files To figure a child's tax in this case, you'll have to fill out Form 8615 and attach it to the youngster's federal income-tax return. If you and your spouse file jointly, the IRS wants the name and Social Security number of the parent who is listed first on the return so that it can ensure your child's tax is figured at the rate applicable to your joint income. If you are married, but file separately, the name and tax ID number of the parent with the higher taxable income must be entered on Form 8615. It gets more complicated for parents who are separated, unmarried, treated as unmarried for tax-filing purposes or remarried. Check the Form 8615 instructions for details if one of these situations applies to your family. Some parents save their child from tax-filing duties by reporting the youngster's investment income on the adults' return. This is an option if a child's earnings are only from interest and dividends, including capital gain distributions, and are less than $9,000. In these cases, the child's investment income is detailed on Form 8814, "Parents' Election to Report Child's Interest and Dividends," and included with the parents' tax return. This way, the child doesn't have to file a return or Form 8615. Child's income could cost parents tax breaks Keep in mind, however, that when a parent adds a child's income to the adult's return, that extra money could mean the loss (or at least a reduced benefit) of some tax deductions and credits that are phased out as income grows. You should run the numbers on Form 8615 and Form 8814 to guarantee that you, and your child, pay the least possible tax on the youngster's investment earnings. If you have more than one child with unearned income, you must repeat this process for each child. Also be sure to know the IRS instructions on determining your child's age. The IRS tax year is slightly different than the calendar year when it comes to the kiddie tax. IRS' kiddie tax ages The kiddie-tax rules no longer applies the year that a child turns 18. That year - if he's not married- he'll be treated as a single taxpayer. For single, the 10% bracket currently goes up to $8,350 of taxable income. The 15% bracket goes up to $33,950. If your child was born on ... Then at the end of 2009, the child is considered to be ... Jan. 1, 1992 18 Jan. 1, 1991 19 Jan. 1, 1986 24 The IRS-designated ages of your children are important because they determine whether the child is subject to the kiddie tax, as well as whether Form 8615 must be filed by the child or whether Form 8814 can be filed by his or her parents. And remember that for kiddie-tax age purposes, only investment earnings are taken into account. Wages and other earned income received by a child of any age are taxed at the child's normal rate. Say Candy Jones, age 15, has $1,700 of interest income from a bank account last year. Shw would owe no tax on the first $950. The second $950 would be taxed at her rate, 10%. That would leave her with a tax bill of $95. But Candy gets a lower 5% tax rate on income from qualified dividends. That's good because most stocks and mutual funds pay qualified dividends. Some dividends paid by real estate investment trusts, foreign stocks and mutual funds holding those securities are not eligible. The 5% rate would mean a tax bill of $47.50 for Candy. With a mix of interest, dividends and capital gains, Candy's tax would be between $47.50 and $95. More details on filing requirements for children can be found in IRS Publication 929, "Tax Rules for Children and Dependents." Adult Taxpayer All the above rules apply to unearned income. Children's earned income is not affected. In fact, a youngster can earn up to $5,700 this year without owing income tax. The amount can be sheltered by the standard deduction. So how should you deal with these kiddie-tax rules? Try to keep investment income for children under 18 below $1,900. Say your children's money is in a money market account. It's earning 4%. Each child could have as much as $47,500 in those accounts. The intereset would be $1,900 this year. That would lead to $95 in tax. Children could hold more assets in dividend-paying stocks and stock funds, if the 5% or even the 0% rate is accessible to them. But giving assets to children that will pay moe than $1,900 in investment income this year would have drawbacks. The excess income will be taxed at the parents' rate. And those assets will be the children's assets when they come of age. That will be 18 in most states, at 21 in others. Then the children can spend the money as they wish. And having more assets in a child's name will cut the family's chances for need-based college financial aid. Some children might already have more assets. That's because their parents anticipated the kiddie tax expiring at age 14. In that case, you might want to spend down the child's account to reduce investment income. You can buy things like a car or a computer for the child. These possessions won't reduce the child's eligibility for college aid. And you can ensure that the money is spent sensibly, if you are concerned your child will spend foolishly when he comes of age. Preventive Measure Another tactic would be to put investment assets into a 529 account. That would shelter them from taxes. And it would discourage wild spending. Junior would be hit with taxes and penalties for non-school withdrawals. The kiddie tax rules no longer apply at age 18. If you trust your child then, you can transfer more income-producing assets to him. An 18-and-up taxpayer can get a standard deduction as well as full use of the 10% and 15% rates. And there might be 5% and 0% tax rates for young adults, depending on what happens in Washington.$ Article Directory: http://www.articledashboard.com Ray Buckner (Chicago, Illinois) provides personal financial planning and wealth management services for professionals in the greater Chicago metropolitan area. His primary focus is serving pre-retirees who are preparing for a successful retirement as well as those who have already retired and want to develop a 100% retirement income personal paycheck. His pre-retiree clients want to focus on replacing 100% of their last year’s income and keep their current standard of living through out their retirement adjusted each year for inflation. www.promoneyreports.com/rbuckner |
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