It’s common for parents, grandparents and others to make gifts to minors and college students. Perhaps you want to help fund education expenses or simply remove assets from your taxable estate. Or maybe you’re hoping to shift income into a lower tax bracket. Whatever the reason, beware of the kiddie tax.
What is the kiddie tax?
For children subject to the kiddie tax, any unearned income beyond $2,100 (for 2016) is taxed at their parents’ marginal rate (assuming it’s higher), rather than their own likely low rate.
For example, let’s say you transferred to your 16-year-old some stock you’d held for several years that had appreciated $10,000. You were thinking she’d be eligible for the 0% long-term gains rate so could sell the stock with no tax liability for your family. But you’d be in for an unhappy surprise: Assuming your daughter had no other unearned income, $7,900 of the gain would be taxed at your rate (15% or 20%, depending on your bracket).
Or let’s say you transferred the appreciated stock to your 18-year-old grandson with the plan that he could sell the stock tax-free to pay for his college tuition. If his parents are in a higher tax bracket, he won’t end up with the entire $10,000 gain available for tuition because of the kiddie tax liability.
Who’s a kiddie?
Years ago, the kiddie tax applied only to those under age 14 — providing families with the opportunity to enjoy significant tax savings from income shifting. Today, the kiddie tax applies to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).
Alternative strategies
Fortunately, there may be ways to achieve your goals without triggering the kiddie tax. For example, if you’d like to shift income and you have adult children who’re no longer subject to the kiddie tax but in a lower tax bracket, consider transferring income-producing or highly appreciated assets to them. Or, if you want to help your grandchild fund college, consider paying tuition directly to his or her school. An added bonus: a direct tuition payment isn’t subject to gift tax.
For more on the kiddie tax and ways to achieve your goals without triggering it, contact your tax adviser.