June 2007
‘Kiddie tax’ age limits are raised to 24
Age limits on the “kiddie tax,” which taxes children’s unearned income above $1,700 at their parents’ rate, have been raised
again. The Small Business and Work Opportunity Tax Act of 2007, passed in May, extends the rule to certain adult children
up to age 24. It includes full-time students whose unearned income does not provide more than half of their support. Last
year, Congress raised the limit from age 14 to 18.
Until last year’s change, shifting investment assets to your children under the Uniform Transfers to Minors and Uniform Gifts to Minors Acts was considered a tax-wise strategy to save for college. At age 14, the investment income in the UTMA and UGMA accounts, held in children’s names with adults as custodians, was taxed at the child’s presumably lower rate. (Children take control of their UTMA or UGMA assets from 18 to 21 years old, depending on the state and account type.)
This latest change in the kiddie tax, which takes effect in 2008, means there’s even less tax incentive now to keep funds in a child’s name, says Mark Luscombe, a tax expert at CCH, a tax information publisher.
BETTER OPTION: 529 PLANS
Last fall, lawmakers made permanent the tax benefits of the Section 529 plan, a more flexible option for financing education. Those plans are owned by adults, and proceeds can be used for a named beneficiary. Money kept in and withdrawn from a 529 plan is free of federal tax--and possibly state tax--if it’s used for qualified higher-education expenses. UTMAs and UGMAs are subject to capital-gains or ordinary income tax, depending on how the money is invested.
What’s more, 529 plans have an edge over UTMAs and UGMAs when it’s time to fill out college financial-aid applications. Changes in federal law last year established that funds in 529 plans are considered the parents’ assets, not the dependent child’s. On the federal student-aid application, up to 5.64 percent of parents’ assets (outside of retirement accounts) are factored in when determining need-based financial aid, while 20 percent of the child’s assets are counted. So sums held in an UTMA or UGMA could count against your child in the financial-aid game.
What should you do if your child has an UTMA or UGMA account? Because that money is owned by your child, it must remain in a custodial account. So, you could cash out the UTMA or UGMA and move the funds to a custodial 529 plan, a type of 529 with your child as the owner and beneficiary. But you’d have to liquidate any stocks, bonds, and mutual funds in the account first--and pay any capital gains tax that is due--since you can only use cash to invest in a 529 plan. Or, if you’ll still have control over the UTMA or UGMA after your child is accepted into college, plan to spend down those accounts by financing education expenses.
Until last year’s change, shifting investment assets to your children under the Uniform Transfers to Minors and Uniform Gifts to Minors Acts was considered a tax-wise strategy to save for college. At age 14, the investment income in the UTMA and UGMA accounts, held in children’s names with adults as custodians, was taxed at the child’s presumably lower rate. (Children take control of their UTMA or UGMA assets from 18 to 21 years old, depending on the state and account type.)
This latest change in the kiddie tax, which takes effect in 2008, means there’s even less tax incentive now to keep funds in a child’s name, says Mark Luscombe, a tax expert at CCH, a tax information publisher.
BETTER OPTION: 529 PLANS
Last fall, lawmakers made permanent the tax benefits of the Section 529 plan, a more flexible option for financing education. Those plans are owned by adults, and proceeds can be used for a named beneficiary. Money kept in and withdrawn from a 529 plan is free of federal tax--and possibly state tax--if it’s used for qualified higher-education expenses. UTMAs and UGMAs are subject to capital-gains or ordinary income tax, depending on how the money is invested.
What’s more, 529 plans have an edge over UTMAs and UGMAs when it’s time to fill out college financial-aid applications. Changes in federal law last year established that funds in 529 plans are considered the parents’ assets, not the dependent child’s. On the federal student-aid application, up to 5.64 percent of parents’ assets (outside of retirement accounts) are factored in when determining need-based financial aid, while 20 percent of the child’s assets are counted. So sums held in an UTMA or UGMA could count against your child in the financial-aid game.
What should you do if your child has an UTMA or UGMA account? Because that money is owned by your child, it must remain in a custodial account. So, you could cash out the UTMA or UGMA and move the funds to a custodial 529 plan, a type of 529 with your child as the owner and beneficiary. But you’d have to liquidate any stocks, bonds, and mutual funds in the account first--and pay any capital gains tax that is due--since you can only use cash to invest in a 529 plan. Or, if you’ll still have control over the UTMA or UGMA after your child is accepted into college, plan to spend down those accounts by financing education expenses.
