Beware The Expanded “Kiddie Tax”

The “Kiddie Tax Rules” have been expanded starting in Tax Year 2008 and will undoubtedly snag more taxpayers.

The “Kiddie Tax” refers to the rules that require a child’s unearned income to be taxed at the parents’ rate of taxation when the amount of a child’s unearned income exceeds $1,700. Unearned income is interest, dividends, and capital gains income.

Prior to 1986, the “Kiddie Tax” only applied to children under the age of 14. Then, Congress changed the law and for tax years 2006 and 2007, the “Kiddie Tax” applied to children under the age of 18. Now, starting in 2008, the “Kiddie Tax” rules apply to children who are under age 19 and to full-time students under the age of 24.

The “Kiddie Tax” comes into play, for example, when parents have given their children money and other investment assets, such as stocks and bond, so that the income from those investments will be taxed at the children’s lower tax rates rather than the parents’ higher rates. This used to be a good tax planning strategy, but obviously, Congress was really bothered by this loophole and has moved aggressively over the past couple of years to close this loophole.

The “Kiddie Tax” is a tax that has taken many parents by surprise as, for example, a couple may be shocked to learn that their 5 year old, to whom they have given investment assets for college, has a substantial tax bill. Of course, the parents then have to file a tax return for the child or the parents can elect to include the investment income on their own return.

Starting in 2008, the expanded age limits for the “Kiddie Tax” is sure to catch many more parents by surprise.