Kiddie tax changes for 2008.

• Author: Dulworth, Cynthia

The tax imposed by Sec. 1 (g) on the unearned income of minor children is commonly referred to as the "kiddie tax" Its purpose is to prevent wealthy parents from shifting unearned income or investment income to their children, who presumably are in a lower tax bracket. The Code achieves this by applying the parents' highest tax rate on the child's unearned income.

Earned income includes wages, tips, contract service income, self-employment net income, and other payments for personal services performed. Unearned income is generally investment income--e.g., interest, dividends, capital gains, rent, royalty, Social Security, and beneficiary distributions.

In 2006, the kiddie tax applied if the following conditions were met:

1. The child's unearned income exceeded twice the child's standard deduction of $850 (i.e., $1,700);

2. The child was under age 18 at the end of the year;

3. One of the child's parents was alive at the end of the year;

4. The child was required to file a tax return; and

5. The child did not file a joint return.

   Age Group Expanded

   The Small Business and Work Opportunity Tax Act of 2007, P. L. 110-28, did not change the basics of the kiddie tax, but broadened its application to include more children. The kiddie tax historically covered children who were of an age that they would still be at home and under parental influence. Now the tax includes the age group that has moved out of the house and is learning to make independent decisions but still needs some parental support to survive. The updated kiddie tax criteria now extend to all children under 19 with the above-stated conditions. The kiddie tax now also applies to a child aged 19-23 if:

1. The child is a full-time student before the close of the tax year; and

2. The child's earned income does not exceed one-half of his or her support.

   There are a few obvious effects from this change. Children and college students from middle-class and wealthy families will owe more taxes due to exposure to their parents' higher rates. Children who generate savings and investments independent of their parents may now need to consult with them on their tax-filing requirements. The advantages to parents from shifting investments that generate current-year income to their lower-tax-bracket children diminish. Gifts of investments may need to be restructured.

   The potentially bigger fallout is the effect from the capital gains rates for the lowest income brackets in 2007 and 2008. For those in the...