Congress Closes 'Kiddie Tax' Loophole

Consider this another step in the "tax accountants full employment act": The latest change in the tax law applies the "Kiddie Tax" to much older kids! The change targets wealthy parents who gift assets to their children to avoid paying their own, higher tax rate.

Until 2005, the tax on a child's unearned income, such as dividends, interest and capital gains, was paid at the parents' marginal rate if the child was under age 14. Last year, the age limit was raised, requiring children under age 18 to be taxed at the parents' rate. Now, starting in tax year 2008, the age limit will apply to children under age 19 -- or to "kiddies" who are full-time students under the age of 24.

Of course, the kiddie tax only applies to unearned income in excess of $1,700. The first $850 is tax free and the next $850 is still taxed at the child's rate.

(Note: This rule does not apply to "earned income" such as from a summer job, or even to a baby who earns modeling fees. That earned income can still be reported on a child's separate return and taxed at the child's lower rate.)

Capital Gains Loophole Closed

The ability to gift appreciated stock to children who would pay lower tax rates was considered a "loophole." By closing that opportunity, the government expects to collect as much as $1.5 billion in extra tax revenues over the next 10 years.

This "loophole" has been a particularly enticing opportunity in recent years because of capital gains rates that have been dropping for those in the lowest two brackets, between 10% and 15%.