Beginning this year, your young children can earn more investment income before the "kiddie tax" kicks in. The kiddie tax rule applies to the investment earnings of a child under age 14. It says that income above a certain threshold amount will be taxed at the parents' top marginal tax rate.
The intent is to discourage "income shifting." This happens when parents try to reduce taxes by transferring investments to their young children or other family members who are in a lower tax bracket.
For 2006, the kiddie tax threshold increased to $1,700, up from $1,600 in 2005. That means your child under age 14 can now earn up to $850 in investment income without paying any tax and an additional $850 that will be taxed at your child's rate. Investment income above that level will be taxed at your top rate.
The kiddie tax doesn't rule out income shifting as a good tax reduction strategy. You can save taxes completely on the first $850 of income that is transferred to each child under age 14, and your child's rate will apply to the next $850.
Children aged 14 or older are not subject to the kiddie tax. Instead, they must file their own tax returns and pay taxes at their own rates. So shifting earning assets to them might still make good sense from a tax viewpoint, depending on their income level and yours.
Remember, though, that giving assets to your children can have other implications. You'll lose control over the assets as the children get older, and there could be gift tax implications. Check with our office for a careful analysis if you think this strategy might work for you.
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