To make the most of the kiddie tax, you can provide children under age 14 with enough assets to earn $1,500 in investment income each year.
Transferring assets to a custodial account for your children can sharply reduce the family tax bill. Assuming a 2.5 percent yield, they could hold $60,000 in assets and earn $1,500 a year, netting at least $1,425, after federal income taxes.
That same $60,000, held in your name, might earn the same $1,500 yet be subject to as much as $525 in federal income tax, leaving you with only $975 per year. Thus, such a strategy could save you $450 in tax, year after year; by the time a newborn is 14 years old and free of the kiddie tax, total tax savings could exceed $6,000.
This strategy has drawbacks, though. The more assets your children have, the smaller their chances of receiving need-based financial aid. Lost aid could outweigh the tax savings so such tradeoffs should be considered.