What do wealthy parents know that you don’t? For starters, they’re well aware that children’s investment income is often taxed at a much lower rate than their parents’. This can include interest, dividends, capital gains and other unearned income. By gifting income-producing assets to children, the income avoids tax or reduces the amount owed.
What are the Rules?
Children who have investment income up to $1800 and meet at least one of three age requirements for 2008 will be taxed at the lower rate.
1. The child is younger than 18, OR
2. The child is 18 and has earned income that is less than half of their own support for the year, OR
3. The child is between 18 – 24 AND a full-time student who has earned income that is less than half of their own support for the year.
In other words, your child at home or your older student child whom you support can report investment income on his or her own return instead of yours. (Of course you will be the one doing all this!) It’s really important to consult with a tax professional on this kind of decision because if you’re gifting assets that may affect eligibility for financial aid for college someday.
Paying Wages to Your Kids
Another way to shift income among family members is to pay children to do business related activities. The business deducts the wages and the child claims the income, which is taxed at his or her (lower) tax rate.
The standard deduction for earned income is much greater than for unearned, investment income. Just make sure if you’re going to do this you keep records such as timesheets and the description of work. The IRS will not look kindly upon the taxpayer who tries to pass her toddler off as a receptionist!
Everyone’s situation is different, but just remember that every little bit helps. Every dollar of income you shift comes right off the top tier – the highest rate of income tax you pay.