Thursday, May 04, 2006

children's investment taxes

Sephanie AuWerter outlined the basic tax rules for children in her "Ask SmartMoney" column in the June 2006 Smart Money magazine.

The key points are as follows:
  1. Children under 14 can earn up to $850 from investments tax free
  2. The next $850 is taxed at their rate
  3. Anything after that (i.e. >$1700) is taxed at the parent's rate

#3, usually catalyzes parents to consider a tax deferred option for their children, such as ROTH IRAs, where the first $4000 can be put.

I checked the IRS website and found the following link that discusses taxes for children with investment income greater that $1,600.

What about regular earnings from newspaper routes to part time jobs, how do they factor in?

Publication 929 discusses tax rules for children and dependents.

  • Part 1 indicates that dependent children must file a return if they have more than $5000 of earned income or $800 in unearned income (investment income). They would also have to file a return if they "had net earnings from self-employment of at least $400."

The actual determination of how much income a child may earn before it is taxed was unclearl. I may research this further. Does anyone have any knowledge on this subject? Most of the document focussed on investment income.

Have a wonderful Friday,

makingourway

2 comments:

GaryP said...

#3, usually catalyzes parents to consider a tax deferred option for their children, such as ROTH IRAs, where the first $4000 can be put.

Of course it is hard to put the money into a Roth for the kids, I believe the rules are that you can put up to $4,000 of "earned" income into a Roth - so cannot shelter investment income without 'giving' them earned income too, and causing more tax problems.

makingourway said...

garyp,

you raise a good point. Any income a child earns will be subject to payroll tax (15.3%). However, there's an important question you can ask.

If you're child works for you and in exchange for earning $4000, pays payroll tax of $600 - with the rest put into a Roth IRA - is the benefit of 40-50 years of tax free growth and tax free withdrawel worth that $600 hit?

Ultimately I think it's a very cheap price to pay for the future tax protection.

Thanks for the thoughts,
regards,
makingourway