The “kiddie tax” is a provision in the U.S. tax code that taxes unearned income (such as interest, dividends, and capital gains) of children at their parents’ tax rate, rather than at the child’s own lower tax rate. The purpose of the kiddie tax is to prevent parents from transferring assets to their children in order to take advantage of the children’s lower tax rates.
The portion of investment income of a child 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:
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1.Go for capital growth oriented mutual fund scheme
Why ? Because then the enhancement in your mutual fund units value will not be paid but reinvested. That way the kids will not have unearned income during the age when kiddie tax rule applies.When the children comes out the age limit for kiddie tax , you can ask for redemption of long term mutual fund invests .
2.Vacant land expected to appreciate in value
It is a historical fact that price of land goes up over period of time. So investment in land will free of kiddie tax over period of time . You can sell the land when the kid is out of kiddie tax age .
3.Invest in closely held company
If you invest in shares/stocks of your closely held company , the said investment may grow with the family business and kiddie tax will not apply as the income from your investment will grow in value , yet no unearned income per year will accrue.
4.Tax-exempt municipal bonds and bond funds;
If you invest in tax-exempt municipal bonds , such unearned income will not be taken for Kiddie tax computation. Some examples of tax-exempt municipal bond funds that are well-known and widely traded,
- iShares National Muni Bond ETF (MUB)
- SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI)
- VanEck Vectors AMT-Free Intermediate Municipal Index ETF (ITM)
- Invesco QQQ Municipal Bond ETF (PVI)
- BlackRock Municipal Income Trust (BFK)
5.Invest in U.S. series EE bonds
U.S EE series bonds is a long term investment in which the income can be deferred until the bonds mature.So, chose a period for maturity of EE series bonds after the age of kids upto which Kiddie tax rule applies.
6. tax-advantaged savings vehicles
If you invest tax advantage funds like below , those investment will not produce the taxable income over a period of time, thus , by the time you get the money in your hand , those will not be subject to the kiddie tax
- Traditional and Roth IRAs, which can be established or contributed to if the child has earned income;
- Qualified tuition programs (also known as “529 plans”); and
- Coverdell education savings accounts which you can contribute up to $2,000 per year per beneficiary, regardless of the number of contributors.
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