The Kiddie Tax was implemented to prevent income splitting between yourself and your children to reduce your overall tax liability. Prior to the Kiddie Tax, business income could be paid to shareholders who were minors in the form of dividends. These dividends could be offset by certain tax credits because the majority of minors have little to no income.

Once the Kiddie Tax was put into effect, these dividends became fully taxable at the parent’s tax rate. The Kiddie Tax did not however apply to capital gains, so tax planners developed structures to turn these dividends into capital gains.   

Shortly after the tax law passed, new provisions were added to include capital gains under the scope of the Kiddie tax. Now capital gains and dividends will be taxed at a higher rate than they once were.

The new provisions do not apply to every situation, so there is a silver lining for those looking to avoid being taxed. Shares listed on designated exchanges, shares of mutual fund corporations, or “excluded amounts” are excluded from subjection to the Kiddie tax.

Another way to avoid the Kiddie tax is to utilize Trusts. Any income earned while in a Trust will be taxed at a lower rate than the parents’, provided that the minor earning the income is in a lower tax bracket than the parents.

If parents wish to include assets as part of their Trusts, they can transfer income generating assets to the Trust, and it will be treated as a sale of the assets at their Fair Market Value at the time of transfer. Any gain between the cost of the asset and the sales price is taxable in the year that the transfer was made.

If the asset that was transferred to the Trust accumulates capital gains, the amount earned will be taxed at the capital gains rate instead of at the Kiddie tax rate. So, these types of capital gains are not yet subject to the Kiddie tax.

 

The above information is of a general nature only and should not be relied upon for specific situations.  We do not endorse the accuracy of the charts on the websites above.  Click here for additional tax accounting services information. 

Call Marlies Y Hendricks, CPA at 416-766-3941 to discuss your best options and set up an appointment.