Kiddle Tax- How To Avoid It?

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What is the kiddie tax?
Previously, the higher income groups used this method for income shifting, i.e. transferring their additional income from different sources; like (income from dividends, capital gains) to their child’s account. It enabled them to pay a lower tax; hence, the government took steps to limit these activities.

Previously, the rule stated that- if, the limit exceeded $2,000; the amount was taxed at the parent’s rate. The tax charged on the minor’s account, from the unearned income at the parent’s rate is termed as kiddie tax.

After a child reaches the age of 18 the entire money is taxed at the child’s rate, and the rules of kiddie tax do not apply.

Strategies used by people to neutralize the rules of the kiddie tax

They used the fund to invest in stocks.
The advantages were-

1. Progressive growth and the positive stocks fetched dividends.

2. After, the child reached the age of 18. The stocks were sold, and the unearned income in the form of a capital gain was not taxed at the parent’s rate. Paying fewer taxes, helped the parents to add on to their savings.

However, to stop the parents from taking undue advantages, the tax laws were changed in January 2008.The new law stated-

  • The money is not taxable, If the custodial account yields an unearned income (from interest or dividend) of $1,000, or less per year,
  • If the custodial account yields an unearned income (from interest or dividend) of $2000 or less per year. Then, the money that will be in excess of $1,000 will be charged at 0%-10%. It must be noted that- Depending on the type of income, the interest rates may vary.
  • If the income crosses $2,000; then the income is taxed at a higher rate of 39.60%.

Now, the rules are even tougher, a minor who attends the age of 18 has to follow the same rule, and will be taxed on the above parameters.

However, there are ways to avoid the kiddie tax-
The major (above 18 years) will have to earn money that will be more than half of his required support. The source of income may include money from self-employment, salary, wages, etc. In this context, the half support means that the child has contributed more than 50 percent to support his/her individual needs.

Putting the money in the name of your child – A hurdle for financial aid

You should never put the money in the name of your child as it will pose a big hurdle in the process of getting the financial aid. The Financial Admission Officer will ask you to fill a need analysis form. They will analyse the form, by taking various parameters into account; like your income, your assets, your parent’s income and assets.

Through this form, the Financial Admission Officers will evaluate your potential to pay for the college.

Neither will they consider the whole valuation of your assets – nor, will they take your full income into account. However, a specific percentage of your income and assets will be evaluated.

  • In the case of the parents – 47 % of your income will be taken into consideration, whereas 5.65% of your assets will be estimated.
  • In the case a child decides to show his/her net worth – 50 % of your child’s income will be taken into consideration, whereas a substantial percentage i.e. 20 % of your assets will be assessed.

The duty of the financial officer is to extract as much money as he possibly can.

The irony is you don’t have to put any money in your child’s name – if you are doing so, you are wasting your hard earned money. The more the amount of the money you put into your child’s fund; the better is your affordability. Hence, if the financial officer feels that you can afford the education, then he/she will ultimately reduce the aid.

In short, by doing so- you are giving the Financial Admission Officer an opportunity to negotiate, and reduce the amount of financial aid.

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