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Find tax shelter when laws collide, but don’t duck and cover

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Two significant tax-law changes are set to collide in 2008: the higher age limits for the “kiddie tax”and the zero percent tax rate for low-bracket sellers of capital assets. But you don’t have to run and take cover.

Strategy: Assess the situation for children in their late teens or early 20s. For many families, it makes sense to pile up security sales before Jan. 1. For others, holding back is the best action.

Let’s take a brief look at the two law changes.

Tax law change No. 1: Under the kiddie tax,unearned income received by a child in a low tax bracket is taxed at the top tax rate of the child’s parents to the extent it exceeds an annual threshold. The threshold for 2008 is $1,800 (up from $1,700 for 2007).

But the kiddie tax isn’t just for kids anymore. Prior to 2006, it only affected children under age14. Then the age limit was raised to 18 through 2007. Beginning in 2008, the kiddie tax applies to any child under age 19 or a full-time student underage 24 if the child doesn’t have earned income exceeding half of his or her support.

Tax law change No. 2: This change has been in the works for a while. Under a 2003 law, the maximum tax rate on long-term capital gain and qualified dividends was lowered to 15%; 5% for low-income taxpayers. The 5% rate (available to someone in the regular 10% or 15% tax bracket) will hit rock-bottom zero for 2008.

Accordingly, you could transfer some of your income-producing assets (e.g., stocks) to your child in a low tax bracket. The transfer is sheltered by the annual gift-tax exclusion, which covers gifts valued up to $12,000 per recipient ($24,000 for joint gifts by a married couple). When your child sells the shares in 2008, he or she pays zero tax on the gain, so long as your combined holding period (by you and the child) is more than one year.

But now you must contend with the new kiddie tax flap. For instance, if your college student/child won’t turn age 24 before the end of the year, the additional stock sales could trigger a tax disaster in 2008.

So your overall tax strategy depends on your child’s age next year:

  • If your child will be under age 18 in 2008, nothing changes.
  • If your child will be between the ages of 18 and 24 in 2008, the kiddie tax may apply if he or she is either under 19 or a full-time student under 24. Generally, this includes children who can be claimed as your dependents. In that case, have your child sell his or her securities in December to take advantage of the 5% maximum tax rate. It’s not quite the zero percent tax rate, but it’s still a good deal. Plus, you have no kiddie tax worries in 2007.
  • If your child will be 24 or older in 2008, have him or her wait to sell the securities in 2008 to benefit from the zero percent capital gains rate. This assumes your child will be in the regular 10% or 15% tax bracket for next year.

Tip: The zero percent tax rate is currently scheduled to extend through 2010. In some cases, your child might wait past 2008 to sell the securities.

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