Financial Gifts for the Kids These Holidays…Or a Present for the IRS?
It is a good time to think about the “kiddie tax,” Uncle Sam’s extra levy on investment income earned by people up to 24 years old. For those making financial gifts to children and grandchildren, these rules present both perils and planning opportunities.
Congress enacted the kiddie tax in 1986 to prevent people from putting assets in their children’s names to reap tax savings, as children often have far lower tax rates than their parents. Under its rules, a child’s “unearned” investment income, such as dividends, interest, and capital gains above a certain amount—$2,100 in 2015—is taxed at the parents’ top rate.
In 2013, the latest year for which data are available, more than 333,000 tax returns owed the tax, totaling about $1 billion.
To avoid pitfalls and maximize the exemptions, here’s what to know.
(1) The kiddie tax doesn’t affect a child’s “earned” income, such as wages from a job.
(2) Under the rules, the first $1,050 of a child’s investment income is effectively exempt from income tax, says Troy Lewis, a certified public accountant who heads Lewis & Associates in Draper, Utah. The next $1,050 of investment income is taxed at the child’s rate, which is often very low or even zero.
(3) The kiddie tax applies to taxable investment income, so sidestepping such income—say, by investing in growth stocks that don’t pay dividends or tax-free municipal bonds—can help avoid it. Timing capital gains can help as well. But beware of surprises.
(4) The kiddie tax treats the family as a unit. If there are several children to whom this levy applies, all their investment income is taxed at the parents’ rate.
(5) If the child’s investment income is less than $10,000, the parents may be able to claim it on their own return—which could be a good option if they aren’t ready to share financial details with the child. The parents also don’t need to reveal income details to minor children, because they typically sign the children’s returns.
Original Story at WSJ.