Some youngsters are treated as "kiddies," for tax purposes, so they have limits on investment income. Over the limits, any investment income is taxed at their parents’ rate. Kiddies include:
* Most children who are under 18 at year-end.
* Any 18-year-olds whose earned income does not top one-half of their total support for the year. Support includes everything spent for the child’s food, lodging, clothing, education, medical care, recreation, transportation, and other necessities.
* Full-time students under age 24 whose earned income does not exceed half of their own support.
(Married couples filing joint returns are not subject to the kiddie tax.)
Suppose Alan Wilson is 21. As a full-time student with little earned income, he is covered by the kiddie tax rules. In 2012, Alan’s first $950 of investment income is tax-free this year while his next $950 of investment income is taxed at his own rate. Any investment income over $1,900 is taxed at his parents’ rate.
Say that Alan’s parents transfer stock to him; Alan sells those shares and takes a $10,000 long-term capital gain. The first $1,900 ($950 plus $950) will be untaxed but the remaining $8,100 will be taxed at his parents’ rate. For maximum tax savings, it’s best to shift investment income to low-bracket youngsters who are not tax-code kiddies.
