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Archives:Avoid the Kiddie Taxby Roy A. Lewis, E.A. Oh, how I long for the "good old days." In tax parlance, the "good old days" were when we could easily transfer money and/or assets to our minor children, and then have the kids sell the assets and/or invest the funds and pay taxes at their lower tax rates. It was a beautiful thing, especially for parents in very high marginal brackets. Imagine taking a $10,000 gain that would have been taxed at your marginal rate of, say, 36% and having it taxed at your kid's rate of 10% or less. Sign a few documents, and the family saves $2,600! But, Uncle Sammy didn't think this tax move was all that pretty, which is why the tax incentives to shift income from a parent to a minor child were nearly eliminated in 1986 when Congress enacted a "kiddie tax." Generally, for a child under age 14 at the end of the year, the kiddie tax provides that the child's unearned income (including capital gains) is taxed at his parents' highest marginal rate. Sure, the kids can receive a floor amount of unearned income that will escape the kiddie tax provisions ($700 in unearned income for year 2000, annually adjusted for inflation). But, it doesn't take much to generate more than $700 in unearned income... especially if the child is invested in a "hot" stock, or receives an unanticipated year-end mutual fund distribution. Planning OpportunitiesThe demise of income shifting to your children has been greatly exaggerated. While it takes a bit more planning, there are still methods that you can use to minimize the kiddie tax and keep your income shifting alive and well. Here are some of the most popular: What about the first 14 years of the child's life? Well, if you can't wait to make significant transfers, the tax will be computed and paid at your higher rate. At least you can avoid the complexities of computing the kiddie tax. Don't despair completely — you can still make smaller transfers during those years and manage the assets for the child to minimize the unearned income. An added benefit is that this maneuver can provide the child some added financial protection if the insurance policy is on the life of a parent. This gambit can also cause some other unintended estate tax problems. So, you might want the help of a qualified estate-planning pro to review all of the relevant issues prior to making such transfers. This is really a last-resort type of dodge. The earnings on savings bonds aren't really what you want to grow the kid's account. Heck, the interest rate hardly keeps up with inflation. But, if the child has a fairly large existing portfolio of growth stocks, and you are looking for some diversification, you can make this type of investment fit the bill. Note, however, if the custodial parent files a joint return with a spouse who is not a parent of the child, the total taxable income shown on the joint return is used to determine the parent's taxable income for purposes of the kiddie tax. These are just a few ideas that you can use to plan around the kiddie tax rules, and there are certainly others. There are enough options available to keep the kiddie tax from completely killing your hope of transferring wealth to the kids at a lower tax rate. It simply takes some additional planning. Related Links: If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2000: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.) December 15, 2000
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