Investing Tax Tips
When considering tax consequences of investing, tears start to roll. This is precisely why you should be completely aware of tax consequences your investments might be subject to. Tax laws and regulations are always changing and are quite complex, so be sure to check with a tax consultant for your particular situation. Below are a few suggestions and general considerations regarding investment income and gift taxes.
Since 1986 the Tax Reform Act has laid the ground work for rules such as the "kiddie tax" for kids under age 14. Even though a particular account may be for a child's benefit and is in an adults name, there is no special tax benefit or leniency. Investment income, A.K.A. capital gains, is still taxed at the adults tax rate.
Here's the breakdown: If you manage a custodial account for a minor that is under the age of 14, the first $700 of the child's annual unearned income (interest and dividends) is free from taxation. The following unearned $700 is taxed at the child's rate (minimum of 15%). Income after these earnings increments are taxable to the child, however, at the parents highest marginal rate (this is the tax rate on the last dollar of income paid).
In most cases, when planning for a child's future, one can safely assume that growth investments are going to be the key ingredient, so income investments will more than likely not be a factor. This is a great strategy for parents planning for a college education because taxes will not be due simply because a stock doubles, for example. Seek growth stocks if you're planning for a college education or simply for the benefit of your children.
Children over the age of 14 have it a bit easier as the tax rules and regulations tend to be a bit more lenient. The first $700 in unearned annual income is tax free just as it is with children younger than age 14. All income earned above $700 is taxed at the child's tax rate, which can be advantageous. Don't begin to think of creative accounting tactics here, however.
Another particularly favorable approach is establishing a Roth IRA for a child, but the child must have earned income. This is a great option because investment earnings are never going to be taxed, even when the time comes to withdraw. It might seem a bit prude, but think of the life lessons that can be taught from saving small amounts at young ages and ending up with a substantial amount of money later in life. Earnings from the child's Roth IRA might be usable for higher education as well (see the Eight IRA Penalty Exemptions for details).
If you're one of those parents eager to help your kids meet their financial goals, then you will want to do so in the most tax efficient way. Currently a single individual can gift up to $12,000 per year per person without paying one penny in taxes on the transaction. Married individuals may gift $24,000 per year per individual. This is a great method of transferring wealth tax free.
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