The IRS has announced a change in the “kiddie tax” rules for 2004. The first $800 worth of unearned income received by a child under 14 will be untaxed while the next $800 will be taxed at the child’s low rate. In 2003, both numbers were $750.
Thus, children under 14 can have $1,600 in low-taxed investment income in 2004. Typically, they’ll owe only $80 in tax: the second $800 will be taxed at the lowest federal rate, now 10 percent. Over the $1,600 mark, the kiddie tax takes effect. Excess unearned income is taxed at the parent’s rate.
Therefore, if you have young children you can transfer up to about $65,000 worth of bank accounts, money market funds, etc., in their names. Assuming interest rates around 2.5 percent, they would earn approximately $1,600 of low-taxed income in 2004. Once your children reach age 14, more income shifting is possible.
You should be aware, though, that money transferred to such custodial accounts will belong to the children, when they come of age, possibly at age 18. If you’re concerned that your children won’t act responsibly, you might be more comfortable keeping the money in your own name and paying the higher tax bill.
