Kiddie Tax Laws

Kiddie Tax Laws

In order to save for their child's college costs, parents open accounts in the child's name. Not only does this designate the fund for the youngster's use, but it also had the tax advantage of having the earnings taxed at the youth's usually lower rate. That changed in 2006.

Kiddie Tax changes used for Federal Programs

In an effort to raise money to pay for other federal programs, Congress changed the child investment earnings rules, popularly known as the kiddie tax, last May. The change, however, was made retroactive to all transactions since January 1, 2006.

Cutoff Age Raised from 14 to 18

Previously, when an account was held in a child's name, any earnings exceeding an annual threshold amount $1,700 in 2006 were taxed at the parents' highest marginal tax rate. But when the child turned 14, his or her usually lower tax rates applied. Now, however, the cutoff age is 18, meaning the higher adult tax rates apply for additional four years.

Your highest marginal rate will be applied to the investment income of your children. So if you're in the 25% or 30% marginal rate, that's what will apply to the investment income instead of the 15% capital gains rate.

In essence, families who had utilized this tax strategy now lose not only the lower capital gains rates that would normally have applied to most long-term investment transactions, but also the benefit of the child's lower rates for any short-term profits. The excess child's investment income is essentially taxed at his or her parents' higher tax rates.

Kiddie Tax Law Dates

Compounding the problem is the date shifting of the law's effective date. People who made a move this year -- rebalanced the portfolio because the youngster is closer to college or they sold assets held by the child to pay for tuition -- they are going to owe more.

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