While Congress has provided many favorable tax breaks to individuals in recent years, the "kiddie tax" has been expanded. With the most recent reform, unearned income over $2,100 for children under age 18 (19 if the child does not provide more than half of his/her own support, or age 24 for full-time students) is taxed at the parents' top rates in 2016. Children owe no taxes on the first $1,050 of unearned income and are taxed at their own rate on the next $1,000. Any additional income is taxed at their parents' highest marginal tax rate.
Original law applied the kiddie tax to children under age 14. This permitted children 14 and older to file their own returns, allowing their taxable investment income, such as dividends and interest, to be taxed at rates most likely lower than their parents' top rates.
Even with the increase in age, there are steps you can take to plan around the kiddie tax. To avoid paying the higher rate, consider the following:
- Shift the child's investments to tax-free securities or growth stocks (which don't pay dividends) that defer taxes until the child is old enough to avoid the kiddie tax.
- Divide the child's income with a special trust. Only undistributed income is taxed to the trust, and distributed income is taxed to the child. At age 21, or when the child satisfies the terms of the trust, the child will receive the principal and accumulated earnings. Be sure to contact us at that time because there will be tax consequences.
- Report your child's income on your return to take advantage of your child's capital gains and offset any capital losses that may otherwise be limited.