The so-called “kiddie tax” may come into play if your child’s unearned income exceeds a specified annual threshold ($1,900 for 2009). In that case, the excess income is taxed at the top marginal tax rate of the child’s parents—regardless of the original source of the funds.
Due to a recent tax law change, the tax generally applies to children who are under age 19 or are full-time students under age 24.
Strategy: Keep your child’s investment income below the $1,900 level. For example, you may have a child invest in growth stock that is expected to appreciate over time, but produce little current income. Similarly, you might redirect some of the child’s investment earnings into tax-free municipal bonds or municipal bond funds.
Another alternative is to invest in U.S. Series EE Bonds. The interest isn’t taxable until the bonds are redeemed or mature. Furthermore, if your child subsequently cashes in the bonds and uses the funds to help pay for college, the interest is tax-free within certain limits.
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