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Tax Code Not So Kid-friendly AnymoreAge At Which Parent’s Tax Bracket Applies to Child’s Unearned Income Increases; CCH Takes a Look at Credits and Exemptions Related to Kids(RIVERWOODS, ILL., January 2007) – The tax code has built a reputation over the years of being family friendly, allowing various types of credits, exemptions and deductions for kids at tax time to help ease the high cost of child-rearing and to encourage “junior” to take that after-school job. However, many higher income parents that have been lining junior’s pockets with highly appreciating assets as a way to shield the income from their higher tax bracket will be in for a bit of a surprise when they do their 2006 taxes, according to CCH, a Wolters Kluwer business and a leading provider of tax and accounting law information, software and services (CCHGroup.com). The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), which was signed into law in May 2006, raises the age at which a child’s unearned income will be taxed at the parents’ rate from 14 years of age to 18 – and the change is retroactive to the beginning of 2006. Before TIPRA, families could make a gift of income-producing assets to a child age 14 or older and have the income taxed at the child’s rate. (The unearned income of a child under age 14 was already taxed as the parents’ income.) In practice, this meant that interest income from investments transferred to a qualifying child would be taxed at 10 or 15 percent, rather than at the 33 or 35 percent it would likely be taxed at if held by parents in the upper income tax brackets. Likewise, any capital gains held by the child would be taxed at 5 percent rather than the parents’ 15 percent capital gains tax rate when the assets were sold. “Putting highly appreciating assets into a child’s name once they turned 14 and then selling those assets before the child turned 18 to take advantage of the child’s tax bracket was a strategy that some parents were using to help save for their child’s college education,” explained CCH Senior Federal Tax Analyst John W. Roth, JD, LLM. “With the new law retroactive to the beginning of 2006, parents who sold assets last winter or spring thought that they could be taxed at their child’s tax rate will be looking at a larger-than-expected tax bill now that they’ll be required to pay taxes on any income and gains from those holdings at their own tax rate.” However, parents who have been amassing small amounts of wealth in their teens’ accounts and have yet to cash them out don’t have very many good choices either. If you sell these holdings before the child turns 18, any income beyond the minimal that is exempt ($850 for 2007) or taxed at your child’s rate (the next $850 for 2007), will be subject to your capital gains tax rate. On the other hand, you could leave the assets in the child’s name until after the child turns 18. However, this comes at its own cost and carries a potentially huge risk. Any income generated from the assets held in your child’s account before he turns 18 will be taxed at your rate (with the exemption of the first $850 noted above and the next $850 taxed at your child’s rate). Then, once the child turns 18, the income and any gain would be taxed at his rate. Assuming he’s still a student or working a summer job, he’s likely in a lower tax bracket. However, you now have considerably less choice in when you sell the holding, for example, the market may be down, but you need to sell now so you can pay next semester’s tuition bill. Even more risky, under many state laws, an individual can assume control of assets held in his name once he turns 18. “You may have put the money in the child’s account with the idea of funding college, but once the child turns 18, he could decide to use it to buy his very first sports car instead of pay for his first semester of college,” said Roth. He noted that the tax law’s age change will likely spur renewed interest in 529 and other qualified college savings plans as parents look for ways to minimize taxes while maintaining control of savings earmarked for their children’s college education. A Look at Basic Credits/Exemptions for KidsFollowing, CCH outlines some simple guidance on the basic tax credits available and the rules for kids’ income..
*Parents can elect to include the unearned income of a child under the age of 18 whose income is less than $8,500 on their return by filing IRS Form 8814 along with the parents’ return. However, while combining the child’s income with the parents eliminates the need for the child to file his own tax return, it will increase the parents’ adjusted gross income (AGI) and, therefore, possibly reduce the parents’ deductions or other potential tax breaks. SOURCE: CCH, 2007 About CCH, a Wolters Kluwer businessCCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax and accounting law information, software and services. It has served tax, accounting and business professionals and their clients since 1913. Among its market-leading products are The ProSystem fx® Office, CCH® Tax Research Network™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. The company provides products and services for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory, and education sectors. Wolters Kluwer has annual revenues (2005) of €3.4 billion, employs approximately 18,400 people worldwide and maintains operations across Europe, North America, and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices. For more information, visit www.wolterskluwer.com. -- ### -- nb-07-12
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