One of the first places to look to ensure your tax bill is not higher than need be is your dependent children. Not only are there tax savings provisions in the tax code like the Dependent Child Care Credit and the Child Tax Credit, there is also the oft-overlooked opportunity to shift taxable income to your children. This opportunity exists because the “progressive” nature of our income tax rates provides an incentive to shift income to lower earning taxpayers. Here are some tips:
Shift unearned income to children.
In 2018, the first $1,050 of unearned income for each child is not taxed and the next $1,050 in unearned income is taxed at a lower rate. Unearned income usually includes anything that is not wages. Typical unearned income includes interest, dividends, royalties and investment gains.
Tip: Transfer enough in assets to each child to approach these annual unearned income limits as closely as possible. Depending on your marginal tax rate you could be saving as much as 49% in federal income taxes each year!
Tip: In addition to the unearned income, consider purchasing investments that will have long-term capital gain appreciation. This potentially provides more flexibility in managing the timing and rate of capital gains when the investment is later sold.
Tip: Remember excess investment income could also subject to the additional 3.8% Medicare surtax. Any investment income that can be shifted to your children could also save you this additional tax bite as well.
Caution: Unearned income above $2,200 in 2019 ($2,100 in 2018)could be subject to the “kiddie tax” if your dependent is under the age of 19 (age 24 if a full time student providing less than 50% of their own support). The excess unearned income could be taxed at a higher tax rate.
Leverage earned income potential with your children.
Tip: If you are a sole-proprietor you may hire your dependent children under age 18 and not be required to pay Social Security and Medicare taxes.
Tip: Since earned income for your children is taxed at their lower tax rates so finding ways to employ your child can reasonable shift income from your higher tax rate to their lower rate. Care must be taken to be able to defend the work being done by your child and the amount they receive for their work. Some ideas include:
- Use your child in an advertisement for your business.
- Have your child clean your office a few times per week.
- Perhaps your child can make deliveries.
- Perhaps your child can help assemble items or help with mailings.
Caution: Moving assets from you to your children could impact their ability to receive financial aid for college. Understanding how your planning impacts college financing should be considered.
There are many opportunities to leverage the tax advantage of our children. Proper planning in this area should include the shifting of income.