Kiddie Tax Increase
The 2007 Small Business Tax Act extends the reach of the “kiddie tax” by raising the age limit to include (1) all children under age 19 (previously under age 18) and (2) students under age 24. Both changes are effective for tax years beginning after May 25, 2007.
The actual computation of the kiddie tax remains the same. The net unearned income of the child (for 2007, generally unearned income over $1,700) is taxed at the parents’ marginal tax rates, if the rates are higher than the child’s tax rates. Only last year, TIPRA raised the reach of the kiddie tax from under age 14 to under age 18.
Impact: College age students will no longer be able to sell off their appreciated investment accounts set up by their parents to cover current tuition. At a minimum, taking out student loans with interest until the year the student turns 24 will be necessary now to carry forward such a plan. However, the maximum tax of capital gains imposed on any stock sales might rise from 15 to 20 percent after 2010, adding another price tag to postponing income recognition.
Impact: The effective date for the new kiddie tax provision brings with it some good news and some bad news. For calendar year taxpayers, the higher age limit starts in 2008. The last hike in the kiddie tax, from age 14 through age 17, in TIPRA was made retroactive to the beginning of 2006. This time, the change is not retroactive and, for most taxpayers, does not take effect until next year. Parents have the option to sell quickly in 2007, while the old rule is still in effect.
Impact: However, because this provision is effective for tax years beginning after May 25, 2007, there is also some bad news. It is not until 2008 that capital gain for those in the 15 percent or lower tax brackets fall to zero rather than 10 percent. That zero no-tax rate remains through 2010. Many lawmakers earlier this year called for preventing dependents under age 24 from using the zero percent rate. The new law covers this “loophole” and more by expanding the kiddie tax.
The new age limit for kiddie tax generally tracks the age test for a “qualifying child” under the uniform definition of child first put into place by the Working Families Tax Relief Act of 2004. At the end of the calendar year, a qualifying child under the uniform definition and for purposed of the new kiddie tax is an individual under the age of 19, or a student under the age of 24. Unlike the uniform definition, however, a child who is permanently and totally disabled will not be excluded from the age test for kiddie tax purposes.
If the earned income of a student over age 17 exceeds half of the student’s support, the kiddie tax no longer applies. Scholarships are not counted in the support test for this purpose.
