New Tax Law That Impacts Families

The “Kiddie” Tax

A change this year in the federal tax rules impacts families with dependent children. No longer do families reap the same tax advantages when investing in a dependent child’s name, as they did prior to 2006. Now, dependent children under 18 years of age instead of 14 years of age are affected by the so-called “kiddie” tax. Originally implemented in 1986, the “kiddie” tax reduced the tax advantages parents gained when they invested money in their children’s names.

Without the “kiddie” tax, unearned income such as interest, dividends and capital gains on a child’s investments might be tax free or taxed at a lower tax rate. The child would likely be taxed at their “lower” earning rate compared to the parents “higher” earning rate. Between 1986 and 2005, a dependent child under 14 could earn up to $750 of unearned income without paying income tax. The next $750 was taxed at either 5 or 10 percent, and anything over that was taxed at the parent’s rate, referred to as the “kiddie tax.” Once a child reached 14, all of his or her income could be taxed at the child’s rate instead of the parent’s.

Beginning in 2006, the “kiddie” tax age increased from 14 to 18 years of age. Under the new rules, dependent children under age 18 are subject to the “kiddie tax.” Dependent children must be over 18 before their unearned income is taxed at the child’s rate instead of the parent’s rate. Therefore, the tax advantage for investing money in a dependent child’s name has been reduced. Also, keep in mind that in North Carolina, money invested in the child’s name becomes the child’s once the child turns 21 years of age.

Another issue to consider before investing in your child’s name is the impact it may have on the financial aid package offered by prospective colleges. Investments in a child’s name will likely hurt the chances of the child receiving financial aid, more so than if the same amount of money is invested in a parent’s name.

For more information refer to IRS Publication 929, Tax Rules for Children and Dependents. Consider consulting with a tax preparer about how the “kiddie” tax may affect your family situation.