A married couple can give up to $22,000 worth of assets to each recipient in 2005, tax-free, because of an annual gift tax exclusion. Such gifts will not eat into either spouse’s $1 million lifetime exemption from gift tax. Subsequently, the income tax bill that follows such transfers will be determined by the “kiddie tax” rules.
According to these rules, children under age 14 pay no income tax on up to $800 worth of unearned income such as interest and dividends, in 2005. They’ll owe only 5 percent tax on the next $800 of unearned income. These $800 limits will gradually increase with inflation.
Thus, a young child can have $1,600 worth of interest income this year and pay only $40 (5 percent of $800) in tax. Any excess unearned income will be taxed at the parents’ tax rate. Thus, for children under 14, custodial accounts should be monitored so that income does not exceed the kiddie tax limit.
Even so, the tax savings can be meaningful. Parents who would owe $448 in tax on $1,600 in investment income this year, at a 28 percent rate, can cut that obligation to only $40 by transferring the assets to custodial accounts. Such tax savings can be enjoyed for each child under 14, year after year.
