“Kiddie Tax” No Longer Just For Kiddies

Years ago, it was the practice of many taxpayers to put investments in their children’s names to lessen the tax bite by having the investment’s income taxed at the child’s rate instead of the parent’s higher rate.  This tactic became so prevalent that Congress stepped in and passed laws that caused most of a child’s investment income to be taxed at the parent’s top marginal tax rate, thereby curtailing the benefit of that strategy.  Because this provision originally applied to children under the age of 14, it was coined the “Kiddie Tax.”

Another favorite tax strategy was to gift appreciated investments, such as stock, to children.  The child would then sell the stock after he or she were no longer subject to the Kiddie Tax and pay a lower tax on the gains.  Beginning in 2003, this strategy further benefited from the gradual reduction of the capital gains (CG) tax rates through the year 2010.  However, with the CG rates dropping to 5% in 2006 and 2007 and then to zero in 2008 through 2010 for taxpayers in the 15% or less marginal tax bracket, Congress took steps to also curtail this strategy by gradually increasing the age at which a child is subject to the “Kiddie Tax” provisions.

The Kiddie Tax now applies to children under the age of 19 AND full-time students under the age of 24.  A child is generally subject to the Kiddie Tax regardless of whether or not he or she qualifies as a dependent of the parents, unless neither parent is alive on the last day of the child’s tax year, he or she is married and files a joint return, or the child is over the age of 18 and is self-supporting (earned income exceeds one-half the amount of his or her support). 

For 2009, the Kiddie Tax rules only apply if the child’s investment income for the year exceeds $1,900.  Unfortunately, the definition of “investment” income for purposes of these rules includes all income other than “earned” income.  Earned income is income from the child’s personal services, such as W-2 income or self-employed income.  In addition, under the Kiddie Tax rules, the child is not allowed a deduction for the personal exemption ($3,650 for 2009), and the standard deduction ($5,700 for 2009) is only allowed to the extent the child has “earned” income.

For more specific information regarding your particular circumstances, please give this office a call.

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