Friday, January 20, 2006

Kiddie Tax for 2006

One of my first and most popular posts was about using custodial accounts for your kids to shelter tax on non qualified dividends and interest. Here is an updated version for the 2006 tax year.


If you have young dependent kids and significant unearned income (interest, dividends, etc.), you can convert a portion of that high taxed income to tax free with a few clicks of a mouse. Here's why: your children can earn up to $850 per year of interest and dividends tax free and another $850 taxed at only 10%. Anything over $1,700 will be taxed at your rate.

Here's what I did:

  1. I created a custodial account for each of my children @ E*Trade (all of my accounts are with E*Trade)
  2. My wife and I made tax free gifts to each of their accounts - each kid got a total of $15k
  3. I invested their new found money into high dividend stocks such as FRO, SFI, ACAS (no need to put the money into stocks that are entitled to the 15% dividend tax - I went for maximum gross dividends)
  4. At tax time, I simply file a IRS Form 8615 for each kid on my return and the income gets tax at the reduced rate.
  5. With 2 kids @ $1700 of income per child, I'll save $782 in taxes just this year! (My marginal rate is 28%)

Words of caution:

  • Always consult a tax adviser if you are unsure of how this would impact you
  • When you give your children money, it's theirs... it can only be used to their benefit or you risk losing the tax benefit
  • Just because it works for me, doesn't mean it will work for you.

UPDATE: Political Calculations has built another wonderful calculator based on this post.

5 Comments:

At 12:21 PM, Blogger WIM said...

Hello Early Riser,
Its with great interest that I read your blogs. I was just reading the 'Kiddie Tax for 2006' and please forgive my ignorance but what do you mean by ".....no need to put the money into stocks that allow the 15% dividend tax..."
Thanks.

 
At 1:19 PM, Blogger Early Riser said...

Monk,

It's clear I need a proof-reader for my posts. I meant to say that there is no need to invest in stocks that necessarily qualify for the reduced 15% dividend tax rate. You can invest in REITS, MREITS and NLP's (all of which usually get taxed at your marginal tax rate) and still receive the kiddie tax benefit.

 
At 1:32 PM, Blogger WIM said...

Early Riser, Thanks for the clarification. I read someplace that such an account (custodial) may impact the chances of your kids getting financial aid. Would you happen to know how big an impact this might have on the chances? Also, I have opened a 529 account for each of my kids. Any comments on whether I should consider the custodial? Thanks.

 
At 1:36 PM, Blogger Early Riser said...

Both custodial and 529 accounts get levied hard by colleges because they are the students' assets. I believe the guideline is something like 35% of the child's assets are expected to be contributed to their college education every year. That being said, I'm only keeping enough in their accounts to earn ~ $1700 per year in dividends. I personally don't expect my kids to get financial aid so I'm not worried about the 'college' impact.

 
At 8:04 PM, Anonymous Anonymous said...

I HEARD THAT PRESIDENT BUSH JUST SIGNED A LAW (MAY 2006) THAT MOVES THE AGE TO ESCAPE THE KIDDIE TAX FROM 14 TO 18. IS THAT TRUE? WILL IT BE RETROACTIVE TO THE BEGINNING OF 2006?

 
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