Definitions

1. In tax year 2007, an underage child is under 18 years old. Beginning in 2008, the same is true except it now includes those children who have reached 18 years and who are full-time students over age 18 but under age 24.  Note: The expanded provision applies only to children whose earned income does not exceed one-half of the amount of their support.
2. A child is under age 18 at the end of the tax year or did not turn 18 on Jan. 1 of the following year. Example: In year 2007, a child born on Jan. 1, 1990, is considered to be age 18 at the end of 2007, even though he or she is not 18 years old until 2008.
3. The unearned income threshold changes annually. For 2007, this threshold is $1,700. The amount of the 2008 annual threshold was not available at this writing.
4. If a child is subject to the kiddie tax, the child’s investment income which consist of qualified dividends or net long-term capital gain are subject to preferential tax rates versus the non-tax-favored other types investment income, such as interests income. The preferential capital gain tax rates in 2007 are 5% and 15%. In 2008, 2009, and 2010 the rates change to 0% and 15%.

Kiddie Tax Planning Options

1. The new law will take affect in 2008, which means children 18 or over may still sell assets through 2007 and pay taxes at their lower tax brackets which includes the 5% rate on qualifying capital gains.
2. Because growth stocks pay little or nothing in dividends, these companies do not have any significant unearned income until shares are sold.
3. Use a buy and hold strategy for tax efficient mutual funds.
4. Series EE U.S. Savings Bonds. Be sure to make an election to report the interests when the bonds mature and plan for them to mature after they would not be subject to the kiddie tax.
5. Because the kiddie tax does not apply to earned income, earned income will be taxed at your child's marginal rates. Even better, the child can also shelter up to $5,350 of 2007 earned income with the standard deduction.
6. Invest in unimproved real estate and do not sell until after the kiddie tax no longer applies.
7. Save for college through a Section 529 plan. If withdrawn for educational use, the distribution is non-taxable for federal income tax purposes.
8. Make IRA contributions based upon earned income. Careful, any investments in the child’s name could hamper the child’s ability to secure financial aid for college.

Attempts to void the kiddie tax require crunching the numbers. Guesses or uncalculated estimates will often result in providing incorrect long-term tax and/or investment advice. Rather than concentrating in reducing the current tax liability, think in terms of reducing the tax liability of the family until that child or children reaches age 18 or 24 and then hope that the tax laws do not change again before that date.

To be continued: Gifts That Don't Count As Gifts

To be continued: Gifts That Don't Hurt College Funding