MONEY MANAGEMENTFrom the Virginia Society of Certified Public Accountants - Presented by Dean Knepper, CPA, CFP®
KIDDIE TAX CHANGES AND OTHER CHILD-RELATED TAX QUESTIONS
(March 1, 2007) -- Watch out. You may be paying more taxes this year if you have a teenager with unearned income or fail to claim exemptions and tax deductions that you deserve. To help you better understand your tax liability, the Virginia Society of CPAs answers questions that parents with children of all ages may have in preparing their 2006 tax return.
What is the Kiddie Tax and how has it changed?
The Kiddie Tax was established in 1986 to prevent wealthy parents from avoiding taxes on their investments by giving these investments to their children. In the past, this rule applied to children under the age of 14. Under a new measure passed in May 2006 and retroactive to January 1, 2006, the reach of the kiddie tax has been expanded to include children under age 18. Here is what that means for your 2006 taxes. For children under the age of 18, the first $850 of unearned income (such as interest, dividends and capital gains) is tax-free. The next $850 is taxed at the child's marginal rate (generally 10 percent), with any amount above that taxed at the parents' highest rate. Once children turn 18, they pay taxes on all unearned income at their own lower rate.
What should I do now that the kiddie tax age limit has been raised?
First of all, keep in mind that a child under age 18 may continue to receive $1,700 of unearned income before paying tax at the parents' higher tax rate. If your child’s portfolio is earning more than $1,700, consider moving toward growth stocks or growth mutual funds that pay little or no dividends. Another option is Series EE U.S. Savings Bonds. As long as your child waits until he or she is 18 before cashing in the bonds, there is no kiddie tax on the accumulated earnings.
I’m ready to file my tax return, but my child doesn’t have a social security number yet. What should I do?
If you file your return claiming your child as a dependent and do not provide a Social Security number on the return, the dependent exemption will be disallowed. You have two options. You could file your income tax return without claiming your child as a dependent. Then, once you have your child’s number, you can file an amended return. The other option is to request a filing extension, using Form 4868. This gives you an additional six months to get your child’s number and file your return.
I adopted twins in December 2006. Are they eligible for the child tax credit?
Yes, they may be eligible. Adopted children are treated the same as natural children under the tax law. To qualify for the child tax credit, your child must: (1) be under age 17 at the end of the tax year; (2) be your child or sibling (either full or step) or a descendent of one of these relatives; (3) be a U.S. citizen or resident; and (4) have lived in your home for more than one-half the year and not have contributed more than one-half of his or her own support during that year. The child can be yours by birth, by adoption, or by being placed in your foster care.
For 2006, the maximum amount of the child tax credit is $1,000 for each qualifying child. Just how much of a tax credit you can take is limited, depending on your filing status and the amount of your adjusted gross income.
I recently returned to work after being a stay-at-home mom. What do I need to know about the dependent care tax credit?
To be eligible for this credit, generally both you (and your spouse if you
are married) must work at least part-time. Your dependent must be under age
13 or a dependent (or your spouse) who is physically or mentally disabled, and
has the same home as you for more than one-half of the year. The credit is
calculated on a sliding scale of 20 to 30 percent of $3,000 of eligible costs ($6,000 for two or more children).
My employer offers a dependent care flexible spending account. Can I use that in addition to the dependent care tax credit?
No, you must choose one or the other. In most cases, if you are in the 28 percent tax bracket or higher, you are better off participating in an employer-sponsored dependent care plan.
What if I have more questions?
A CPA can answer questions regarding your tax return and help you develop a strategy for lowering your tax bill by maximizing child-related tax breaks.
The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.
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