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Planning for the new "kiddie tax"
by Joe Hurley, founder,
Tuesday, October 30th 2007

[Updated March 12, 2008]

Actually, the kiddie tax has been around for a long time. What's new is that beginning in 2008, the kiddie tax can ensnare individuals up through the age of 23. In 2007, the kiddie tax applied only to children below the age of 18. Obviously, this is a big change and it's bound to impact millions of families.

With the kiddie tax, the parents' tax bracket is substituted for the child's tax bracket on the child's unearned income above a certain level. In 2008, the income threshold is $1,800, up from $1,700 in 2007.

Here's an example. Suppose you are in the 28% federal income tax bracket in 2008, and your 17-year old child has interest income of $3,000, with no earned income. Without the kiddie tax, your child's federal tax liability would be $210 ($3,000 minus the $900 standard deduction, taxed at 10%). With the kiddie tax, your child's liability climbs to $426, because $1,200 of the interest income is now taxed at 28% instead of 10%.

If we changed the example by assuming the income is long term capital gains, the kiddie tax increases your child's federal tax liability from $0 to $180. We simply substitute the relevant capital gains rates of 0% and 15% for the ordinary income rates used above of 10% and 28%.

Who below the age of 24 is not subject to the kiddie tax in 2008?

-Your child is 18 to 23 and has "earned" income of more than one-half his or her total support.
-Your child is 19 to 23 and is not a full-time student. A full-time student is someone attending college on a full-time basis for any portion of at least five months during the year.
-Your child is married and filing a joint return. This exception was also available in 2007, but we don't see too many 17-year olds filing joint returns.

Section 529 plans can be a terrific investment option that forever avoids the kiddie tax, provided the withdrawals end up coming out tax-free. They should be at the top of the list of college-savings options for any parent who has cash to invest, or who plans to come into some cash when triggering gains.

» Claiming a state income tax deduction - 12/20/16
» Understanding 529 Investment Options - 12/13/16
» Should you open an UGMA/UTMA 529? - 02/06/08
» Understanding your state's slice of 529 fees - 12/13/07
» Planning for the new "kiddie tax" - 10/30/07
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