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Kiddie Taxes

On May 25, 2007, President Bush signed the Small Business and Work Opportunity Act of 2007. As one of the revenue generating features of this bill, the Kiddie Tax was increased again.

One long time tax reduction strategy is to shift income within a family to a member in a lower tax bracket. The Kiddie Tax is designed to limit that provisions. If a minor has unearned income (usually interest, dividends, or capital gains) in excess of a certain level, the excess is taxed at the parent's marginal tax rate.

In 2006, TIPRA changed this tax from children under 14 years of age to children under 18 years of age. Unfortunately, that was retro-active to the beginning of 2006.

Now the applicable age has been changed to under 19 years of age, or under 24 years of age if the person is a full-time student. This effectively tracks the "qualifying child" rules for dependency. Fortunately, this time the change does not go into effect until the tax years beginning after enactment, which was May 25, 2007. For most individuals, that means 2008.

This income-shifting technique is very often used to finance a child's college education. When a parent has stock with high appreciation, they gift it to their child over the number of years required to avoid the gift tax. The child receives the stock with the parent's basis. So when the child sells the stock, they recognize the large capital gain rather than the parents. Generally that means it is taxed (currently) at a 5% rate. Had this rule not been changed, the tax rate applicable for this technique beginning in 2008 would have been 0% -- tax free!

A key point is that this technique of financing college is still applicable. There is no extra tax applied as long as the total unearned income of the child is below the threashold for that year:

2018 2019 2020
$2,100 $2,200 $1,100

A significant point is that 2007 is the last year that children ages 18 and over escape this extra tax bite. Beginning in 2008 all 18 year olds are subject to the extra tax, and all full-time students under the age of 24 will be subject to the extra tax bite.

Note that California does not conform to this federal tax provisions, so potentially there are still significant California income tax savings available in 2008 and beyond without changes.

"Tax software is no substitute for tax knowledge."

Any views expressed herein are based on our best information. The content of this web site was written as general information without specific individual information and thus may not apply in all situations. This material was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

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Janelle Ogg, EA
Richard Ogg, EA