Most recently, Congress again expanded the tax in the Small Business and Work Opportunity Tax Act in 2007. In addition to increasing the age limitation for the tax, Congress added a new level of complexity by creating three separate classes of taxpayers, each subject to different requirements for the imposition of the kiddie tax.
The first class of taxpayer consists of everyone who was subject to the tax before the most recent changes. This group consists of children under the age of 18 at the end of the calendar year who: (1) have investment income in excess of $1,700 (the threshold has been increased from $1,600), and (2) do not file a joint return (i.e., are not married). The second group, added by the 2007 legislation, consists of children who are age 18 on December 31, and who: (1) have investment income in excess of $1,700; (2) do not file a joint return; and (3) do not have earned income (self-employment income or wages) that exceeds 50% of their own support. Finally, the third group, also added by the 2007 legislation, consists of children who are age 19 through 23 on December 31 who: (1) have investment income in excess of $1,700; (2) do not file a joint return; (3) do not have earned income that exceeds 50% of their own support; and (4) are full-time students for at least five months of the calendar year.
Therefore, the new kiddie tax now generally applies to all children under the age of 18 and to children who are over age 18 but under age 24 and are full-time students. Given the expanded kiddie tax, you should consider the following issues before transferring assets to your children for tax-saving purposes (Note: there may be other valid reasons to gift assets to your children):
- First, a child’s investment income exceeds $1,700, it is best to avoid making gifts of income-producing property (at least for tax-saving purposes) until the earlier of the year the child reaches age 24 or has completed his education.
- Second, a gift of appreciated property can escape the “kiddie tax” if its sale is deferred until after the child has reached the appropriate age.
- Third, gifts of property that generate tax-free or tax-deferred income, i.e., municipal bonds, Series E Savings Bonds, insurance policies, and deferred annuities, are fine, because they will not generate any taxable income while the child is subject to the “kiddie tax.”
- Fourth, gifts of investment property to grandchildren may make sense, if their parents are in a lower marginal tax bracket than the grandparents; it is the parents’ tax rate that counts, not the donors’. Finally, consider a gift to a 529 college savings plan. It is a completed gift for estate planning purposes and, because the income is tax-free to the beneficiary, it escapes the “kiddie tax.”
If you would like to take advantage of this new tax law or if you have any questions regarding this new law, please contact Burke Costanza & Cuppy LLP.