How to Work Around Intricate 'Kiddie Tax' Rules

Julien Block for AccountingWeb.com writes: The Tax Reform Act of 1986 introduced the complicated "kiddie tax" rules. They drastically restricted the ability of higher-bracket parents and grandparents to shift investment income from themselves to their lower-bracket children and grandchildren by gifts of cash, stocks, mutual fund shares, real estate, money and other inc[sniome-generating assets. It's possible to work around them, but you have to know all the ins and outs.

How did Congress clamp down on income-shifting maneuvers? Our lawmakers targeted children under the age of 14 who received investment income. The 1986 act imposed theparent's top rate on such income. But children who had attained the age of 14 were unscathed by that year's version of tax reform. The legislation retained the old rules for those children. It said they should continue to be taxed at the children's rate.

When did the 1986 measure apply parental rates to children's income? When a child underthe age of 14 received "unearned" income. This meant investment income from interest, dividends, capital gains from sales of assets or distributions from mutual funds, rents, and other kinds of unearned income.

The act authorized some relief from kiddie taxes. They kicked in only when a child's investment income exceeded a specified threshold that subsequently was adjusted annually, as explained below. No relief, though, for earnings that were generated by money or other assets received by the child from persons other than parents—grandparents or aunts, for example.

The rules introduced by the 1986 act have been amended several times. But previous versions and the one on the books for 2014 are consistent. They generally tax the excess income at the parent's top rate, which can be much higher than the child's. For instance, they tax interest income at the rates for salaries, pensions, profits from self-employed ventures, and other kinds of ordinary income.

For 2014, those rates go as high as 39.6 percent, versus a top rate of 20 percent for dividends from stocks and stock funds and for long-term capital gains from sales of individual stocks, shares of mutual funds and most other assets. Note that 2014's maximum rate is more than 39.6 percent for individuals subject to: the Medicare surtaxes on investment income or earnings; or phase-outs for dependency exemptions and certain itemized deductions because their adjusted gross incomes surpass specified amounts.[snip]  The article continues @ AccountingWeb, click here to continue reading...