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Congress changes tax on children’s investment income

Congress has changed the “kiddie tax” – the tax that must be paid on children’s investment income.  If any of your planning involves gifts to children, you might want to reconsider your strategy in light of the changes.

In the past, the “kiddie tax” provided that if a child under age 14 had investment income above a certain amount – the income was taxed at the parent’s tax rate, not the child’s tax rate (assuming the parents’ rate is higher).

Under the new rules, the kiddie tax applies to 18-year-olds.  It also applies to children under 24 if the child is a full-time student.  (However, the tax won’t apply if a child’s earned income accounts for more than half of his or her support.)

The change is designed to eliminate a strategy where parents gave their children assets that had appreciated in value.  The idea was the children could then sell these assets at a lower capital gains tax rate, because the capital gains tax is reduced for people in lower income brackets.

This change doesn’t mean it’s no longer a good idea to give assets to children.  But you might want to be more careful about what assets you give and how they are invested.

For instance, assets placed in a 529 college savings plan won’t be subject to the kiddie tax as long as they are eventually used to pay for college.

Also, in some cases it will be appropriate for children’s assets to be put into investments that don’t generate a lot of taxable income, such as municipal bonds, savings bonds, real estate, low-dividend growth stocks, or family limited partnerships.

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