Shifting income to your children’s low brackets may bring substantial family tax savings.
Kiddie tax: Children under age 14 are entitled to $700 per year in unearned income, tax-free, and another $700 to be taxed at the lowest federal tax rate of 15%, in 2000. Excess amounts of unearned income are taxed at the parents’ tax rates, which tend to be higher. This year, parents in the 28% tax bracket could save nearly $300. In a higher bracket, the tax savings can be greater. State tax savings may be available, too.
Teen tax trimmers. After children reach age 14, more income shifting is possible. Each child is entitled to a full 15% federal tax bracket, which covers income up to $26,250 this year, for single taxpayers. Such children get a bargain 10% rate on capital gains, too. Thus, parents who intend to sell appreciated securities can give those securities to their children after age 14 and have the children sell the securities.
A married couple can give up to $20,000 worth of assets each year to a child without incurring a gift tax. You and your spouse might give your 14-year-old $20,000 worth of mutual fund shares that you bought for $8,000 several years ago. If you sold those shares, the federal tax on the $12,000 gain would be $2,400, at 20%. Your teenager can sell the shares and pay only $1,200, at 10%. Again, state tax savings may be available, too.
Earned income. Your family may enjoy even greater tax savings if you or spouse are in a position to hire your child, perhaps for a professional practice or a sideline business. The money you pay will be deductible by yourself or by your company, saving you as much as $396 per every $1,000 paid out, in a top 39.6% bracket.
In 2000, the standard deduction shelters up to $4,400 worth of earned income for single taxpayers. You might pay your children $4,000 to work for you and deduct the full amount while your children owe no income tax on the money they earn.
In order for this to work, your children must receive the going rate for work actually performed. Keep records showing the work they did: they should be treated the same as any employee. Without good records, the IRS might challenge your deductions for the amounts paid to your children. With a solid paper trail, you may even deduct compensation paid to young children for simple tasks.
