Here’s Some Ways to Negate the Kiddie Tax

June 15th, 2014 at 2:32 PM

The Kiddie Tax was created by lawmakers to prevent taxpayers from shifting income to their children to take advantage of the child’s lower tax bracket. This tax can arise also without income shifting as well.

Does your child have investment accounts that generate income? If so, the kiddie tax could negate their low individual tax bracket, and subject them to you higher tax bracket. For 2014, your child pays the kiddie tax only on unearned income in excess of $2000. So, if your child has $3000 of unearned income, only $1000 is subject to your higher tax rate. Here’s the important tax planning point to this discussion-the kiddie tax does not apply to all of your children’s income, but only to their unearned income, such as, dividends, rent, capital gain, interest, and S Corporation distributions.

The kiddie tax applies to children with more than $2000 of unearned income when the child:

1. has to file a tax return
2. does not file a joint return
3. has at least one living parent at the end of the year
4. are under age 18 at the end of the year
5. are age 18 at the end of the year and did not have earned income that was more than half of their support, and
6. are full-time students over age 18 and under age 24 at the end of the year who do not have earned income that was more than half of their support

Tax Planning Strategies

1. The kiddie tax does NOT apply to earned income. As a business owner, you can take advantage of this rule, and hire your child or children. The hiring comes with an extra benefit, you can deduct the wages pay to your employee-child. If you operate as a sole proprietor or single-member LLC, both you and your child are exempt from payroll taxes until the child becomes 18 years old. If you operate as a Corporation, you are subject to the payroll taxes regardless of age.

2. IRA Strategy—If your child has earned income, you can utilize an Individual Retirement Account (IRA) to shield their unearned income from the kiddie tax. For example, let’s say your child earns $6200 through employment, and has $5000 in distributions from the stock they own in your S Corporation. Their total income of $11,200 is sheltered from tax due to the IRA deduction of $5000 + the standard deduction of $6200. In addition, if your child is not subject to kiddie tax and has earned income, then the Roth IRA is an even better strategy to consider.

To summarize:

1. Know if your child is subject to the kiddie tax
2. Be aware that there is no kiddie tax on earned income
3. Utilize tax planning strategies such as the mentioned above to negate this tax