Tax planning and compliance for investors
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By Kaye A. Thomas
Updated March 5, 2009
Certain children that have investment income above a threshold amount have to pay tax at their parents' rates.
At one time, wealthy families could save a great deal of money by transferring investment assets to minor children. Tens of thousands of dollars in investment income produced by those assets would be taxed to the children at the lower rates that apply to individuals who have relatively little income. Congress decided to limit the tax benefit from shifting income to children, so we now have a law that says certain children that have more than a small amount of investment income have to pay tax at their parents' tax rate.
Originally this rule applied to children under 14 years of age, and it became known as the kiddie tax. Congress moved the age limit up to 18 as of 2006, and beginning in 2008 it can apply to students until they reach age 24, making the term kiddie tax something of a misnomer. See below for details on who is affected.
You don't have to worry about this rule until your child has investment income greater than a threshold amount, which is two times the amount allowed as a standard deduction for a dependent who has only investment income. For 2009, that amount is $950, so the kiddie tax begins to apply when your child has more than $1,900 in investment income.
Your child can still owe regular income tax with less than $1,900 in income. This is merely the threshold amount of investment income for the special kiddie tax.
The application of the kiddie tax depends partly on your child's age as of the end of the year. For this purpose a child born January 1 is treated as if he or she reached the age of that birthday on December 31 of the previous year. We now have different rules for four different age groups:
The kiddie tax doesn't apply if your child is married filing jointly.
If your child has more than $1,900 in investment income, the tax is figured according to a special calculation. The first $1,900 of investment income is still taxed at the child's lower rates, but any additional investment income is taxed at the parents' rates.
Example: In 2009 your child has $2,900 of interest income and no other income. The first $950 of investment income escapes taxation: your child's standard deduction takes care of that. The next $950 is taxed at the child's rate of 10%. That leaves $1,000 to be taxed at whatever rate would apply if this income were added to the income reported on your tax return. Suppose you're in the 28% tax bracket. The tax on your child's income would be 10% of $950 plus 28% of $1,000, for a total of $375.
Even though the tax is calculated at the parents' rate, it is still the child that owes the tax, not the parents.
There are two ways to apply the parents' rate to the child's income.
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