“Can you please explain the kiddie tax to me?”
The Kiddie Tax is the Federal government’s effort to close some tax loopholes that parents were using by attempting to shelter income or other funds by putting them in their children’s name. This is because traditionally both earned and unearned income were taxed at a lower tax rate for children, in part (but not only) because they typically earn less, and so are in a lower tax bracket.
This is still true for income which a child (meaning, here, someone under 18 years of age) has earned.
However, where the Kiddie Tax comes into play is for unearned income, meaning income which accrues to the child through passive or gratuitous means, such as interest or dividends. Often, parents would pass on unearned income to children in order to take advantage of the lower tax hit enjoyed by their children.
The way the Kiddie Tax works is that instead of taxing unearned income which accrues in a child’s name at the lower rate that a child would ordinarily enjoy, the unearned income is taxed at the parents’ tax rate. Shazaam!… putting passive income in your child’s name is no longer a sheltering tax loophole.
Now, children are still allowed a certain amount of unearned income, and have it taxed at the lower rate, before the Kiddie Tax kicks in. In the year 2007, that amount is $1,700. And any income which a child actually earns (as compared to unearned income) is taxed at the child’s actual tax rate.
So, in essence, the Kiddie Tax applies to any unearned income accrued to the child after the first $1,700 (in 2007 – that number is likely to change in subsequent years). After that first amount, all unearned income acquired by the child will be taxed at the parents’ tax rate.