If you have a child who turned 18 in 2007, you are in luck, taxwise. But that’s the only bright spot for families burdened by what is called the kiddie tax.
The tax is, in effect, a penalty on parents who saved for their child’s college by putting money into custodial accounts at a time when today’s tax-free education savings vehicles weren’t widely available or used.
“It has ruined wonderful planning people have been doing for years, people who were thinking ahead, who gave their child income-producing assets they would use when the kid went to school,” said Harvey Aaron, senior tax manager at Braver PC in Newton, Mass., and director of tax services at Braver Wealth Management.
Here’s how the kiddie tax works: If a child is under 18, he or she is allowed to have $1,700 in unearned income – nonwage income such as dividends and interest on investments – before the kiddie tax kicks in. (There’s no tax on the child’s income of $850 or less, and the next $850 in income is taxed at the child’s ordinary income tax rate, usually 10 or 15 percent.)
For unearned income over $1,700, the child’s tax is computed at the parent’s tax rate, which can be as high as 35 percent. A child who turned 18 in 2007 isn’t subject to the kiddie tax and will pay 2007 tax at his or her lower rate.