Advanced Personal Finance

How Children’s Savings Are Taxed - the ‘Kiddie Tax’

A friend was depositing birthday money into his kids’ savings accounts the other day and asked me about taxes. I’m not a tax attorney by a long shot, so I did some investigating. I wanted to write about what I found so I’d kind of have it in my own ‘archives’ in case it ever comes up for me and my children.

The Kiddie Tax

There are basically three rules regarding children’s savings taxes:

Only unearned income is taxed this way. Unearned income is capital gains, dividends, and interest earned. Any earned income is taxed like an adult’s income.
It affects children under age 18. On the year of the child’s eighteenth birthday, the Kiddie tax no longer applies.
It only matters for unearned income above a certain threshold. In 2007, that number is $1,700. Kids don’t have to report unearned income under $1,700.

Filing Forms

The IRS form for the Kiddie tax is Form 8615 (Tax year 2006 form here). You use that to add to the child’s 1040 if it applies. You can also pay the tax on the parents’ return by filing Form 8814 (2006 form here), as long as the child’s unearned income is less than $8,500 (as of 2006).

‘Getting Around’ the Kiddie Tax

It’s possible to minimize the effects of the Kiddie tax.

First, the child can invest in stocks that pay little or no dividend income. He or she can also use municipal bond funds. The tax effect is the same. The capital gain at sale is the only thing to be concerned about.

Second, your kid doesn’t actually have to be eighteen for the tax treatment to change. It only has to be the year he or she turns eighteen. At that point, he or she is an adult for IRS purposes. This could come into play when paying for college.

taxes

2 Responses to “How Children’s Savings Are Taxed - the ‘Kiddie Tax’”

James Says:
July 12th, 2007 at 10:39 am
I think it’s important to share that starting in January 2008, the kiddie tax age limit is increased to dependents under 19 and full-time students under 24. That means that if your child isn’t covered this year but would be next year - you should consider doing any “gifts” before Dec 31.

Here’s a link explaining the rules changes -
http://www.kiplinger.com/features/archives/2007/06/kidtax.html
The Sunday Review #29 Says:
July 15th, 2007 at 1:42 pm
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