Transferring investments to your children to take advantage of their lower tax rates may seem like a good idea. However, before you execute this income shifting strategy, consider how the “kiddie tax” might apply.
The kiddie tax applies when a child has taxable unearned income (as opposed to earned income from a job) above a certain limit ($2,100 in 2015). The rules affect children under age 18 and children who have earned income that is no more than half of their support and are either age 18 or full-time students under age 24.
Once the tax is triggered, the following rules generally apply:
- The child has a standard deduction equal to $1,050*
- The next $1,050 of unearned income is subject to the child’s rate
- Additional unearned income above $2,100 is taxed at the parent’s rate
Example. Bob is in the 25% bracket and his 16-year-old son, Todd, has no income other than $2,500 in investment income. Todd’s standard deduction shields the first $1,050, the 10% rate applies to the next $1,050, and Bob’s marginal rate applies to the remaining $400, for a total tax of $205. Alternatively, if Bob had kept the investments and paid the tax himself, he would have paid 25% of $2,500, or $625.
Is It Worth It?
Though tax savings are possible, consider also the added administrative expense of maintaining a second investment account. And, if your child is going to attend
college, assets held in his or her name may reduce future financial aid awards. You may want to consider a Section 529 college savings account, which produces investment earnings that are tax free if used for qualified education expenses.
* For 2015, the standard deduction will equal the lesser of $1,050 or the child’s earned income plus $350.