Why do you trade? Is it for financial security or freedom of time? For many of us, we trade to provide and leave a legacy to the ones we love. But what’s the best way to do this without getting in trouble with Uncle Sam?
When children are under the age of 24, investment income, capital gains and any other “unearned income” above a certain amount will be subject to Kiddie Tax Rules. This means the income will be taxed at the parents’ tax rate.
However, there are strategies for parents to sidestep Kiddie Taxes and divert some of a child’s investment income into a lower bracket. Often, this involves using appropriate asset classes to either defer receiving income now in turn for long-term growth.
You could purchase U.S. savings bonds for your child and defer the payment of interest until the child is no longer subject to the Kiddie Tax. All the interest would then be taxed at the child’s tax rate.
Municipal bonds are another option. Because muni bonds are exempt from federal income tax, you won’t owe federal tax on the interest the bond earns while your child is younger (and subject to the Kiddie Tax). If the muni bond is ultimately sold at a profit, it would be taxed as a capital gain at the child’s capital gains tax rate, provided you waited until the child was no longer subject to Kiddie Tax rules.
Dividend ReInvestment Plan (DRIP) Mutual Funds reinvest dividends into the fund and are a great way to avoid paying taxes right away on dividend income, which would otherwise be subject to Kiddie Tax. You could then wait until after the child ceases to be subject to the Kiddie Tax to sell — for example, the year the child graduates from (or drops out of) college or turns 24, and the profit will be taxed at the child’s capital gains rate.
Tax-managed Mutual Funds are specifically designed to generate little taxable income. Again, you could sell them for gain after the child ceases to be subject to the Kiddie Tax.
Kiddie Tax rules aside, gifting can still prove to be a worthwhile tax strategy. Everyone’s situation is unique and the rules are complex. Let OTA Tax Pros guide you on how to get the most out of your gifting strategy! Visit us as www.otataxpros.com.