Free «Kiddie Tax» Essay Paper
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Initially, kiddie tax was only applied to unearned income of children below the age of fourteen. However, the rule currently applies to each child below the age of 19 and to full-time students under 24 years old. The kiddie tax affects the children below 19-24 only if their earned income is less than the half of the yearly expenses for their support. Kiddie tax denotes the charge, imposed on the investment income of a child at the parent’s rate under particular conditions. It was introduced in the Tax Reform Act of 1986 by Congress to aid in preventing the wealthy parents from evading tax by concealing their income investments in accounts under their children’s names. Gifts are non-taxable, but if the gift generates an unearned income investment, then the tax applies. It is convenient to include a child’s income investment on a parent’s return. Nevertheless, the parent’s gross income alters, which means that it disqualifies for specific income-based credits and deductions. The IRS distinguishes such unearned income investments as capital gains, bonuses, and interest, as well as earned incomes of children, which they acquire under their names through the accounts, opened by parents. This paper discusses the kiddie tax with a focus on how it works and analyzes staying within the kiddie tax limit.
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How the Kiddie Tax Works
Under the U.S tax system the income, generated from the property, is taxed to the property owner (Nevius, 2015). The property, which belonged to someone different than the owner, who benefited from the income, was taxed at a lower rate. The Congress involved into this situation in order to discourage the habit of income shifting (Brunson, 2011). Congress does not usually impose the tax liability on the definite recipient rather than the money owner, except for acknowledging the abuse existence about the kiddie tax (Nevius, 2015). Congress’ concern was about the grandparents and parents, who avoided paying taxes by assigning their properties, mostly income, to their grandchildren and children (Pomerantz, 2008). Therefore, the property income would be taxed at a smaller marginal rate, since children are taxed at lower rates, compared to the adults. In this case the principal beneficiaries of the income remain the asset controllers due to the influence they have over the minor, shifting income-generating properties. It is the ultimate means for the taxpayer with high-income to reduce the tax liability (Brunson, 2011).
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Kiddie tax considers children as suitable taxpayers, although parents have transferred the property to them (Nevius, 2015). The kiddie tax changes the applicable rate of a child’s passive income in order to prevent the income shifting tax advantages. Kiddie tax results mainly in taxing the lower percentage on each unearned income of the child compared to the parent's higher marginal tax rate (Nevius, 2015). The Congress’s earlier proposal would allow kiddie tax to apply only to the unearned income, linked to the minors’ assets, shifted by parents. However, the kiddie tax was extended by the Conference Committee to be applied to each unearned income, which a minor receives, regardless of the source of the asset, from which the child obtains the income (Lieuallen, 2008). The kiddie tax manages a minor’s tax liability until the child becomes unliable to it and, while both of the parents or one of them is alive, or if the kid fails to file the year's joint return (Pomerantz, 2008). Initially, a child becomes unliable to the kiddie tax whenever they turn 14-years (Nevius, 2015). However, the age limit was increased from fourteen to eighteen years by the Congress in 2005 (Lieuallen, 2008). In 2007 the Congress declared that kiddie tax is applied to children and raised the maximum age (Lieuallen, 2008). According to the existing law, children might stop being liable to the kiddie tax only if they earn income, dependent on some child’s circumstances (Pomerantz, 2008). When an income, earned by a child, accounts for more than a half of the year support, eighteen years is the earliest age the child can no longer be liable to the kiddie tax (Nevius, 2015). When the kid’s earned income equals to a half of the support, or is less than it, the child will stop being liable to the kiddie tax on the 19th birthday. A different situation occurs if the child is a student. When a child is a student and the earned income comprises a half of the year support or less, then the kid continues paying the kiddie tax until the 24th birthday (Lieuallen, 2008).
According to the estimation of the Taxation Joint Committee, the revenue produced for the government by the kiddie tax between 1987 and 1991 was $1.004 billion (Nevius, 2015). A significant increase is witnessed from $60 million in 1987 to $195 million in 1988. In 1989 the revenue accounted for 226 million, in 1990 it was $249 million, in 1991 there was a profit of $274 million, and it has been increasing ever since (Nevius, 2015). The Internal Revenue Service data showed that almost 274,000 kids needed to file a Form 8615 regarding the kiddie tax in 1988 (Brunson, 2011). Out of the 274,000 children, on whom the kiddie tax was imposed, more than 19% had the year’s income below $5000 (Nevius, 2015). The number of youngsters, obligated to file the Form 8615 reduced to 142000 in 2005 (Nevius, 2015). The extended age limit from 14 to 18 years old in 2006 raised the number of young people, appropriate to the kiddie tax to 331,000 (Brunson, 2011). The kiddie tax doubled, contributing the revenue of $645.2 million in 2006 (Nevius, 2015). If the child is liable to the kiddie tax, he or she is obligated to calculate the tax liability using the twofold parallel systems, including the total amount, owed under the kiddie tax and the amount, which is owed if he or she is not under the kiddie tax (Lieuallen, 2008). Therefore, the child would pay the higher of the two amounts. The child is obliged to determine the net unearned income, the adjusted gross income, not recognized to the child’s compensation for service rendered, professional fees, salaries, and wages, in order to aid in calculating the indebted amount, using the kiddie tax (Pomerantz, 2008). The child’s net unearned income is reduced further by an inflation-adjusted minimum amount (Pomerantz, 2008). It also includes the dividends, interest, and capital gains. Gifts do not appear in the gross income that is why they are not subjected to kiddie tax (Lieuallen, 2008).
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The child should calculate the taxable income by either ignoring or applying the kiddie tax after counting the net unearned income tax (Lieuallen, 2008). The calculation of the tax liability without the kiddie tax determines the amount of the child’s outstanding dues in case he or she was an adult (Brunson, 2011). When calculating the tax liability using the kiddie tax, net unearned income of the child should be deducted from the taxable income (Nevius, 2015). The child is taxable on any salary, wage, professional fees, and other various compensation incomes under the kiddie tax at their marginal rate (Nevius, 2015). However, the tax applies to the parent’s top marginal rate on each unearned income of a child. Because of the kiddie tax, the liability of the minor is higher than the ordinary one (Pomerantz, 2008)., The Internal Revenue Code complexity is raised significantly by the kiddie tax, which requires a child to determine his or her kiddie tax liability in addition to the ordinary tax liability when receiving an unearned income yearly (Pomerantz, 2008). For the minor to comply with the Internal Revenue Code filing necessities, his parents are obliged to provide him with the taxpayer identification number (Brunson, 2011), while the child under the kiddie tax should include the taxpayer ID number on his tax return. However, the kiddie tax is complicated because it provides a choice to comprise the child’s gross income to the parent’s tax return (Lieuallen, 2008). Although this choice is limited, it can be applied when the child’s annual incomes include only dividends and interest (Lieuallen, 2008). If during the year a child has any passive incomes, then he or she has to pay kiddie tax and the administrative costs.
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Staying Within the Kiddie Tax Limit
The Internal Revenue Income sets the minimum kiddie tax every year. It is not advisable to have a child liable to the kiddie tax if the income tax exceeds the minimum kiddie tax amount (Lieuallen, 2008). If a child has 5% of his earnings spent on paying the kiddie tax annually, so, compared to the minimum of $2,100, he or she would have $42,000 more over the minimum amount in assets or in cash (Nevius, 2015). Children between 19-23 years, who are not full-time students, with the earned income less than a half or exactly the half of their year support, would not be subject to the kiddie tax (Pomerantz, 2008). Also, it relates to the children of age 24 and above, who are their parents’ dependents (Nevius, 2015). For instance, if a child is not subject to the kiddie tax, parents can transfer all their assets to him so that the unearned income is taxed at the lower individual rate. Otherwise, if the child is subject to the kiddie tax and stays within the age limit, a parent can shift properties, which appreciated in value with time but it is possible to generate revenue only by trading (Brunson, 2011). Therefore, the minor is eligible to sell the property only when he turns 24. An example of the appreciated investments includes municipal bonds. An individual can purchase the municipal bond for his offspring that is maturing when the child is not liable to the kiddie tax anymore (Pomerantz, 2008). Since the municipal bonds are free from the federal income tax, the principal property beneficiary will not owe the federal tax on the interest, which the municipal bond earns, while the child is below the age to be subject to the kiddie tax (Pomerantz, 2008). If the parent waits until the child does not become liable to the kiddie tax before selling the municipal bond at a profit, then he would be taxed at the rate of the child’s capital gains (Pomerantz, 2008).
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Another investment that increases over the time is growth mutual funds also known as a growth stock (Pomerantz, 2008). Parents can buy their children resources in the form of the shares from organizations that reinvest their revenues for the future development instead of paying taxable dividends to their stockholders (Brunson, 2011). When the child turns 24, he or she stops being subject to the kiddie tax and the parents sell the shares, since the returns will be taxable under the rate of the child’s capital gain (Nevius, 2015). Besides, an individual can purchase funds with investments, which reflect stock index, and are expected to generate yearly threshold taxable income (Pomerantz, 2008). Policy makers are to decide if the ability of a family to pay tax is accurately calculated by aggregating the household income irrespective of the payable income among family members, or by separating the individual’s ability to pay taxes without involving other family members’ income (Lieuallen, 2008).
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The kiddie tax applies to a child's unearned income, exceeding the threshold amount. The Congress adopted the kiddie tax with the purpose of discouraging parents from shifting their investments to the children’s accounts in order to reduce the taxes. The term kiddie tax was derived from the fact that only minors under 14 years were liable to it. Children are subject to the kiddie tax if they are under the age of 18 and their unearned income exceeds the established minimum amount. Children at the age of 18 with an earned income below the half of their year support are also eligible to it. In addition, a child who is subject to the kiddie tax should be a full-time student between the age 19-23 with an earned income that is less than the half of his year support.