The Kiddie Tax taxes all “unearned income” a child makes at the parent’s marginal tax rate. It is another way Uncle Sam has created to take the money from the more “affluent” Americans. Truthfully, the Kiddie Tax does not only affect the well to do, but everyone who wants to do some tax planning using their kids. Shifting income to your kids, to be taxed at their lower rate, has traditionally been a way to save taxes and is very popular. It is actually a tried and true tax planning technique and has been used by wealthy families for decades.
Shifting income involves moving a moneymaking asset to the children’s ownership so that any income from the asset will be the children’s and not Mom and Dad’s. By shifting the income to the kids who don’t earn as much total income as Dad, taxes are reduced. This is because Dad lowers his adjusted gross income (AGI). A family can realize a ten or fifteen percent tax savings on the money earned by the children’s assets.
Shifting income is just plain smart. If you are a professional, imagine putting your business equipment into an LLC held by your kids. Your main business will then rent the equipment from the LLC. Your business will get a tax deduction for paying the rent on the equipment and your kids LLC will the get money. If your rent is less than $2,000 a year per child, your kids will pay less tax because they make less money and their tax rate is lower than yours is.
In today’s high tax environment, you get an additional bonus by shifting income, the shift results in lowering your adjusted gross income or AGI. Under new tax laws, having a lower AGI is a big deal, because an individual’s adjusted gross income is the key element in determining an individual’s tax bracket. By shifting income, the end result is that the family has more money to spend.
Kiddie Tax Specifics
The “Kiddie Tax” was passed by Congress some time ago, to stop parents from shifting income to the children. The Kiddie Tax is only imposed on unearned income, not earned income, because the income shifted to the kids was a result of rent paid to them. They didn’t earn it by working for wages. The IRS calls it “unearned income.” Earned income is the income an individual earns by working with sweat equity. The Kiddie Tax says that for kids up to 18 years of age, any unearned income will be taxed at Daddy’s rate.
The age was 14 years of age until just recently. Now it is 18 years old, and if the child is a student and Mom and Dad claim the child on their tax return as a dependent, the age is 24 years old. Shifting income has had its wings clipped by the Kiddie Tax, but it is still an important device in avoiding taxes.
The Kiddie Tax is also discriminatory. I know a young man who worked hard and used his money to buy a piece of real estate and fix it up and rent it. The income the young man got from the asset had to be taxed at Dad’s rate. It didn’t matter that his Dad had nothing to do with the asset.
Unearned Income Tax Credit
Fortunately, a $2,100 unearned income tax credit is given to each “child” annually. So, each kid can make up to the $2,100 limit before the Kiddie Tax kicks in. So the IRS doesn’t tax the first $2,100 in unearned income. The IRS is your major impediment to financial success; either in your own personal life or in your business life. The only way you will ever control taxes is to know the legal tricks and traps. Shifting income has been a traditional way to lower an adjusted gross income and while it still works in a limited fashion, there are other ways to lower your AGI. In my Advanced Tax Tactics Course I have included a number of other tax strategies.