text: Apr 23, 2021, 11:43am EDT
  Apr 23, 2021, 09:54am EDT
  May 30, 2007, 06:00am EDT |
  As reported on May 2 in a Forbes.com article, "Rich College Kids: Take A Tax Hike," Congress wants children and college students who come from wealthier families to pay more taxes to offset tax breaks given to small businesses.
  Late last Friday, members of Congress got what they wanted when President George W. Bush signed the Iraq spending bill that included new rules for the so-called "kiddie tax," a law that applies to dependent children who have unearned income (dividends, interest and capital gains) in excess of $1,700.
  The kiddie tax law was originally established to prevent well-off families from abusing the strategy of shifting unearned income to their children, where it would be taxed at a lower tax rate than their own. Under the kiddie tax, any amount of a child's unearned income in 2007 in excess of $1,700 is taxed at the parent's tax rate. Until recently, the kiddie tax only applied to children under the age of 14, but in 2005, the Tax Increase Protection and Reconciliation Act moved the age to 18, and the new legislation that was passed on Friday expanded it further: Effective Jan. 1, 2008, the kiddie tax will apply to children age 18 and younger as well as college students under the age of 24.
  In the legislation, the kiddie tax is considered to be an offset provision for tax breaks given to small businesses, but there is more to the story. Congress got a little nutty when it passed a previous law that allowed the capital gains tax rate to drop all the way down to zero in 2008 for people in the lowest tax brackets. Then they realized that even kids from wealthy households could be in the lowest tax bracket. So they passed the new kiddie tax and turned all of our American "kiddies" into little Dutch boys to plug the hole in their legislative dike and give small businesses a break.
  The stated intention in Washington was to pass laser-guided legislation targeted only at wealthy families, but there apparently was some confusion between the pilot and the weapons officer, because the collateral damage will be felt in all American households, rich and poor. The kiddie tax doesn't just tax rich kids--it taxes all kids who save and invest their money. The rules don't say that if you have unearned income over $1,700 and your parents are rich, you will pay a higher tax. You pay a higher tax rate if your unearned income is over $1,700, period.
  Fortunately, there are some tactics that can be employed to stay ahead of the game.
  Starting in 2008, kids under the age of 19 should focus on three things: 1) limiting their taxable unearned income until they are older and won't have to pay the kiddie tax, 2) investing in tax-deferred Coverdell Education Savings Accounts and 529 college savings plans, and 3) seeking the maximum after-tax return on their investments.
  College students who are currently over the age of 18 can take advantage of the present law by selling appreciated stock and mutual fund holdings before the end of the year and realizing those capital gains on their 2007 tax return. By doing so, they will pay capital gains taxes at their own tax rate (typically 5%) for 2007 instead of paying capital gains taxes at their parents' typically higher tax rate (15%) if they wait to sell in 2008.
  Starting in 2008, the only way that college students under age 24 will be able to avoid the kiddie tax is if they provide over half of their own support from their earned income (wages and salaries).
  So what should a college kid from a wealthy family do with $100,000 in highly appreciated stock that was given to her as a gift by her parents and grandparents? If she passes the support test for dependency, she could use the standard deduction, personal exemption and the Lifetime Learning tax credit on her own tax return to eliminate the federal tax on up to $21,800 in long-term capital gains per year, even though she would be subject to paying capital gains taxes at her parents' tax rate (15%) under the kiddie tax.
  At the end of the day, the kiddie tax leads to a higher tax bill, and families will ultimately move to one side of the investment fence or the other--529 college savings plans or alternative types of accounts and investments used in combination with the education tax credits.
  Troy Onink is chairman of Stratagee.com, a financial services firm focused on helping families determine and implement Your Best Strategy ® to pay for private school and college, and the author of Strategy & Simplicity--for Private School and College Funding, which will be released in June 2007. He is also author of the new content area on college planning for myStockOptions.com.