The “kiddie tax” rules will be a bit more lenient in 2006. Children under age 14 can have as much as $1,700 in favorably-taxed unearned income, up from $1,600 in 2005. In 2006, each child under age 14 may have $850 worth of investment income that’s untaxed. The next $850 will be taxed at the child’s rate.
Generally, that rate is 10 percent, the lowest federal income tax rate. However, dividends from stocks and stock funds as well as net long-term capital gains are taxed at only 5 percent in 2006, for low-bracket taxpayers. Thus, if a “kiddie” has dividends or net long-term gains, an allocation must be made.
For example, suppose your nine-year-old daughter has $850 in interest from a bank account and $850 in stock dividends in 2006. Her total unearned income would be $1,700.
The first $850 is untaxed.
The next $850 is taxed at a blended rate: half as ordinary income and half as qualified dividend income.
If half of that $850 is taxed at 5 percent and the other half at 10 percent, the blended rate is 7.5 percent. Thus, your daughter’s tax bill would be only $63.75: 7.5 percent of the second $850 in unearned income.
