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* Since 1987, taxpayers wanting to shift income to children subject to lower tax rates had to consider the kiddie tax when the children were under 14 years old. TIPRA, which became law in May 2006, made a significant change in the kiddie tax retroactive to the beginning of 2006.
* Children under 18 years old are now subject to the kiddie tax if they have net unearned income.
* Computing the kiddie tax is often complex, and some income normally subject to preferential tax rates, such as dividend income and net capital gain, might not be taxed at those preferential rates.
Can your clients put their teenagers on the payroll? Preferring earned income to unearned for their children is just one way parents are paying closer attention to how much and what kind of dollars flow to their offspring. Before the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), earnings didn't enter the picture as often, since only children under 14 were subject to the "kiddie tax'--having to use their parents' tax rate to compute their tax liability for net unearned income. Under TIPRA, the kiddie tax applies to children under 18 for tax years beginning after 2005, so many more taxpayers must now consider it.
[As this article went to press, President Bush had just signed legislation extending the kiddie tax beginning in tax year 2008 to 18-year-olds (19-23 if a full-time student) whose earned income does not exceed half their support.]
Arranging for children to have earned income is just the beginning. Some types of unearned income, such as qualified dividends, can still be taxed at rates as low as 5%, provided the child's total income is low enough, and the higher rate of 15% is still often lower than the parents' marginal rate. But--here's where a little of the dread creeps in--the proportion of net unearned income that may receive dividend treatment is limited to the ratio of dividend income to total unearned income. Other hurdles and ways of reckoning with them include parents reporting children's net unearned income on their own return--of course, with its own set of consequences. This article describes some computational issues including deductions available to dependents and offers planning ideas not only to lessen tax liability where possible but also to coordinate funding aims for families, including saving for college. Along the way, it offers some pointers on calculating the tax for more than one child at a time---even in today's blended families.
COMPUTING THE TAX
If the kiddie tax applies, form 8615 is used to compute it and is attached to the child's form 1040 or 1040A. The child's net investment income is reported on form 8615, then combined with the taxable income of the parent (unless otherwise indicated, parent in this article also applies to married …