Transferring Assets Through the Kiddie Tax

Transferring-Assets-Through-the-Kiddie-Tax

Many people wonder how they can save taxes by transferring assets into their children’s names. This tax strategy is called income shifting. It seeks to take income out of your higher tax bracket and place it in the lower tax brackets of your children. When transferring assets through the kiddie tax, be sure you’re aware of the rules.

Kiddie Tax Rules and Rates

While some tax savings are available through this approach, the “kiddie tax” rules impose substantial limitations if:

  1. The child hasn’t reached age 18 before the close of the tax year, or
  2. The child’s earned income doesn’t exceed half of their support and the child is age 18 or is a full-time student aged 19 to 23.

The kiddie tax rules apply to your children who are under the cutoff age(s) described above, and who have more than a certain amount of unearned (investment) income for the tax year — $2,300 for 2022. While some tax savings on up to this amount can still be achieved by shifting income to children under the cutoff age, the savings aren’t substantial.

If the kiddie tax rules apply to your children and they have over the prescribed amount of unearned income for the tax year ($2,300 for 2022), they’ll be taxed on that excess amount at your (the parents’) tax rates if your rates are higher than the children’s tax rates. This kiddie tax is calculated by computing the “allocable parental tax,” and special allocation rules apply if the parents have more than one child subject to the kiddie tax.

Note: Different rules applied for the 2018 and 2019 tax years, when the kiddie tax was computed based on the estates’ and trusts’ ordinary and capital gain rates instead of the parents’ tax rates.

Be aware that to transfer income to a child, you must transfer ownership of the asset producing the income. You can’t merely transfer the income itself. Property can be transferred to minor children using custodial accounts under state law.

Possible Saving Vehicles

The portion of investment income that’s taxed under the kiddie tax rules may be reduced or eliminated if the child invests in vehicles that produce little or no current taxable income. These include:

  • Securities and mutual funds oriented toward capital growth;
  • Vacant land expected to appreciate in value;
  • Stock in a closely held family business, expected to become more valuable as the business expands but pays little or no cash dividends;
  • Tax-exempt municipal bonds and bond funds;
  • U.S. Series EE bonds, for which recognition of income can be deferred until the bonds mature, the bonds are cashed in, or an election to recognize income annually is made.

Investments that produce no taxable income — and therefore aren’t subject to the kiddie tax — also include tax-advantaged savings vehicles such as:

A child’s earned income (as opposed to investment income) is taxed at the child’s regular tax rates, regardless of the amount. Therefore, to save taxes within the family, consider employing the child at your own business and paying reasonable compensation.

If the kiddie tax applies, it’s computed and reported on Form 8615, which is attached to the child’s tax return.

We Can Help You with Reporting Options

Parents can elect to include the child’s income on their own return if certain requirements are satisfied. This is done on Form 8814 and avoids the need for a separate return for the child.

The tax professionals at Ramsay & Associates can help with transferring assets through the kiddie tax. If you have questions about the rules for income shifting, contact us. We can help.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

What to Know If Your Business Closes its Doors

What-to-Know-If-Your-Business-Closes-its-Doors

Sadly, many businesses have been forced to shut down recently due to the pandemic and the economy. If this is your situation, we can assist you, including taking care of the various tax responsibilities that must be met. Here’s what to know if your business closes its doors.

Filing a Final Tax Return

Of course, a business must file a final income tax return and some other related forms for the year it closes its doors. The type of return to be filed depends on the type of business you have. Here’s a rundown of the basic requirements.

Sole proprietorships. You’ll need to file the usual Schedule C, “Profit or Loss from Business,” with your individual return for the year you close the business. You may also need to report self-employment tax.

Partnerships. A partnership must file Form 1065, “U.S. Return of Partnership Income,” for the year it closes. You also must report capital gains and losses on Schedule D. Indicate that this is the final return and do the same on Schedule K-1, “Partner’s Share of Income, Deductions, Credits, etc.”

All corporations. Form 966, “Corporate Dissolution or Liquidation,” must be filed if you adopt a resolution or plan to dissolve a corporation or liquidate any of its stock.

C corporations. File Form 1120, “U.S. Corporation Income Tax Return,” for the year you close. Report capital gains and losses on Schedule D. Indicate this is the final return.

S corporations. File Form 1120-S, “U.S. Income Tax Return for an S Corporation,” for the year of closing. Report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.

All businesses. You may need to file other forms to report sales of business property and asset acquisitions if you sell your business.

Personnel and Contractors

If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits, and report employment taxes. Failure to withhold or deposit employee income, Social Security, and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.

If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”

Additional Tax Matters

If your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met by a terminating plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for your employees.

You may come upon other complicated tax issues related to closing your business. We can assist you with matters including debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.

In addition, we can advise you on the length of time you need to keep business records. You also must cancel your Employer Identification Number (EIN) and close your IRS business account.

If your business is unable to pay all the taxes it owes, we can explain the available payment options to you.

We Can Help

When it comes to tax obligations, the business tax professionals at Ramsay & Associates can help you understand what to know if your business closes its doors. Contact us to discuss these issues and get answers to any questions.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.