Kiddie Tax Rules

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The Kiddie Tax rules were implemented to prevent income splitting with children to reduce 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 rules were put into effect in 2000, 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 thereby avoiding the tax.

In 2011, new provisions were added to include certain capital gains under the scope of the Kiddie Tax.  The new provisions did not apply to every situation. Capital gains on shares listed on designated exchanges, shares of mutual fund corporations, or “excluded amounts” are excluded.

Trusts can be an effective way to avoid the Kiddie tax. Any income earned in a Trust can flow through to a child beneficiary and taxed at a lower rate than the parent’s, provided that the child is in a lower tax bracket than the parent.

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 is transferred to the Trust accumulates capital gains, the amount earned in the Trust will be taxed at the capital gains rate instead of at the Kiddie Tax rate. So, these types of capital gains are not subject to the Kiddie tax.

 

The above information is of a general nature only and should not be relied upon for specific situations.  Call Marlies Y Hendricks, CPA at 416-766-3941 or submit email enquiry form below to set up a consultation.

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