Other Issues in Kiddie Tax
Deferring Income to Avoid the Kiddie Tax
Several years ago Congress raised the kiddie tax age from 14 to 18 (19 to 23 if a student) to prevent parents from transferring appreciated assets to their children to take advantage of the lower capital gains rates and especially the 0% rate.
Given the current age rule, a parent may not want to make transfers of income-generating stocks, bonds, and other investments to children age 18, or those age 19-23 who are full-time students. However, placing or moving a child's funds into investments such as the following that produce little or no current taxable income, can help avoid the Kiddie Tax, at least in the years until the investments need to be sold or redeemed to pay for education expenses:
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U.S savings bonds – Interest can be deferred until the bonds are cashed.
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Tax-deferred annuities - Interest can be deferred until the annuity is surrendered.
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Municipal bonds – Generally produce tax-free interest income (may be taxable to the state).
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Growth stocks - Securities and mutual funds oriented toward capital growth that produce little or no current income.
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Stock in a closely held family business - That is expected to become more valuable as the family business expands, but pays little or no cash dividends.
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Unimproved real estate – That provides appreciation without current income.
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Family employment - If the family has a business, that family business could employ the child. The child’s earned income is not subject to Kiddie Tax and will generate a deduction for the family business (assuming the wages are reasonable for work actually performed). The child’s earned income can offset the standard deduction and the excess income will be taxed at the child’s rate (not the parent’s tax rate). In addition, the child would also qualify for an IRA, which provides additional income shelter.