Tax-saving strategies for your kids, whether they go to college or not
Every time Washington clamps down on the complicated kiddie tax rules, parents have to figure out different ways to encourage their kids to save.
The latest move came at the end of May, when Congress tucked another kiddie tax change into the Iraq spending bill. Starting with tax year 2008, any "kids" who are full-time students will be taxed at their parents' rate until they are 24. That's a further restriction from last year's tightening, which bumped up the age at which kids could be taxed at their own rates from 14 to 18.
All in all, it wipes out some useful tax-saving strategies.
There's little point in parents saving in their children's names for college, or even waiting until the kids are in school to give them stocks they can sell at a profit. They'll pay the same capital gains taxes on those profits that their parents would.
That's kind of a shame, mainly because it penalizes kids who really want to build their own savings from grandparent gifts and the like. But there are still a few ways to help kids get the joy (and some tax relief) of building assets.
For 2007, kids over age 18 are taxed at their rate. So if you wanted to lay some profitable stock on your 18- to 24-year-old college student and have her sell it to pay tuition (and presumably lower capital gains taxes than you would pay), now is the time. By next year it will be too late.
The rules apply only to unearned income, so any money your child legitimately earns will be taxed at his, presumably lower, tax rate. And you can hire your child to do household tasks, drive errands, or even model for the cover of your latest company brochure. It gets complicated if junior wants to save too much of that money; the interest and dividends he receives on his savings are what will be taxed at his parents' rate.
Some savings are OK. These rules don't kick in until the child has over $1,700 in so-called "unearned" income -- dividends, interest, and capital gains payments. That would let your child build up to about $21,000, earning about 8 percent a year, before having enough income to trigger the higher tax rate.
There are some tax-smart savings vehicles for kids. It's hard to beat a Roth IRA as a place to stash money your daughter or son earns. Once the money is in the Roth, it's not taxed at all. They can pay income taxes on it when they withdraw the money to pay for grad school or buy a house. Even better, they can just forget that the money is there. Every $1,000 put in a Roth IRA now will grow to $54,000 in 50 years if it earns 8 percent a year.
Stocks are a sweet alternative. Kids who really want to learn about saving and investing on their own might be encouraged to buy shares of individual company stocks that interest them -- or shares of mutual funds that have little turnover. Those investments won't generate much taxable income until they are sold, which can be after the "child" turns 24.
The tighter rules make 529 college savings plans look more attractive, too. The income in these accounts is never taxed if it's used for college. Also, you can change the account beneficiary to another family member. Some states even give tax credits for contributions. But, some of these plans are fee-laden and underwhelming. Find out how your state's plan rates but look at others too. Find them all at savingforcollege.com.
Paying for college may well become an exercise in deferral. Depending on how much money is at stake, some families might find it worthwhile for students to take out loans to pay the bills, and then help them pay it off later.
After graduation, parents can give shares of stocks that have big gains, and new graduates can sell them at their, presumably lower, capital gains rate. (The capital gains rate for most middle income taxpayers is 15 percent; for low-income tax payers it is 5 percent and for one year, in 2008, it is actually zero for those low-income tax payers.)
Sale of a large holding with a big gain, done in 2008 at zero percent could save a family thousands of dollars in taxes, but it's a risky strategy.
Tax law could change again before then; the money spent on private student loan interest could overshadow the tax savings on this strategy.
Linda Stern is a freelance writer. She can be reached at lindastern@aol.com. 
