Smart Reasons to Save, Use and Invest Money

Does Kiddie Tax Create Inequality

First below is the basic information about what Kiddie tax is (this is from irs.gov)?

If the child’s interest, dividends, and other investment income total more than $2,000, part of that income may be taxed at the parent’s tax rate instead of the child’s tax rate. See Form 8615 Instructions, Tax for Certain Children Who Have Investment Income of More Than $2,000.

Part of a child’s investment income may be taxed at the parent’s tax rate if:

  1. The child’s investment income was more than $2,000
  2. The child meets one of the following age requirements:
    • The child was under age 18 at the end of the tax year
    • The child was age 18 at the end of the tax year and the child’s earned income does not exceed one-half of the child’s own support for the year, or
    • The child was a full-time student who was under age 24 at the end of the tax year and the child’s earned income does not exceed one half of the child’s own support for the year (excluding scholarships)
  3. At least one of the child’s parents was alive at the end of the tax year
  4. The child is required to file a tax return for the tax year, and
  5. The child does not file a joint return for the tax year
Spock-like
Fascinating

Okay, now with the basic definition of what Kiddie tax is, here are the reasons that I think that kiddie taxes could be a cause of wealth inequality.

  1. To be taxed at your parents rate is punitive and teaches young student that investing is bad.  Teaching that investing is bad to young people encourages them to miss out on one of the greatest wealth builders in the United States.
  2. Another huge disensentive is the tedious and complex tax filing consideration.  Why even try?  Young Adults have enough complexities with live without this complex and head ache of a rule.  Why even try?
  3. It’s hard enough for kids to divert money from spending on fun things to know that the government a huge bite out of the earnings right away.  Again, why even try?

In conclusion, I have to believe that the Kiddie tax does more harm that good.  Perhaps the government should re-evaluate the way that they are discouraging the young to consider investing because of the Kiddie Taxes (after all a 23 year old is pretty old and not a kid anymore).

It’s sad that we complain that kids aren’t being taught finances in school on one hand, but then in the other hand our taxing system is screwing young adults if they decide to go that route.  Where is the fairness here?

At a very minimum, the threshold amount should be raised from $2,000 to $5,000.  At $5,000 it’s not entirely fair either, but at least it’s less of a disinsentive to participate in the greatest wealth builder in America (ask Warren Buffett).  And to think of all of those projections that say “start early”, but I wonder how many of those projects calculate the huge tax bite that the government may take out of their investment projection models?

I think it a horrible lesson for our youth, and the pros (teaching kids to invest) outweigh the cons (bad folks taking advantage of their kid’s brokerage accounts for tax purposes.  Besides, these days the government can detect such transactions that are questionable…  I wonder if the government even realizes the potential harm they are doing on kids and young adults?

I write a lot of what I consider unique things (or at least I think them), and I sometimes worry about others might copying my content… but this is one area that I would gladly allow to be paraphrased, and even encourage it!

What do you think? 

Don

 

8 Responses to Does Kiddie Tax Create Inequality

  1. The kiddie tax is a relatively new tax implemented in 1986. I would be happy to see it go away, as long as the government can actually detect people shifting money to their lower-taxed dependents. I’m not sure that is really the case, though.

    • All transaction thru financial institutions could be traceable. Back in the 80s, perhaps not so much, but today… definitely.

      I still think it’s ironic that inequality is the latest focus, but the punitive nature of the “Kiddie tax” definitely discourages young adults to invest their money.

  2. I think it should be abolished. If we are worried that rich parents are going to take advantage of their children’s lower tax rate then maybe we could have restricted accounts for children that only allow a certain amount of contribution per year (kind of like how we do with 401K accounts).

    • Hmmm, pretty cool idea Levi. :)

      I wish the gov. would think about it some more and come up with a better solution.

      The “real” rich can put thousands of dollars in their kids accounts and let it grow. The “real” rich don’t need the money and their kids get wealthy in the process.

      If a kid work hard via a paper route or whatever and try to save (perhaps money for college, or a car), they get a bad deal in that they have to pay their parent’s tax rate when the have over $2,000 in unearned (aka invested) income. It’s kind of like hitting someone when they are on the ground in my opinion.

  3. If the kids put it in an IRA, wouldn’t that make it a moot point?

    Also, to have $2000 in investment income seems like they would have had to stash away quite a bit. I can’t imagine there would be too many dependent kids putting away that much. You would need 20K with a 10% return to make that threshold. Am I missing something?

    • As a college student, I used all of my income for college and college life. So there was no way I was going to put the money I made in the stock market in a Roth IRA.

      It’s capital gains (an important aspect of investing) that kills student’s earnings. If you had 5k and invested it in a stock like WAGE or VIPS in 2013, you’d have a 170% gain So that would be a 8.5k gain, of which 6.5k would be taxed high (at their parent’s rates), then on top of that, you’d also have to bother your parents (or maybe yourself, I’m not entirely sure here) to file special complex tax forms, or worse hire an accountant. If you were lucky enough to have 20k, then that would be: 34k in capital gains. Get my point?

      It’s not hard to have a great year like 2013. But taxes make it every painful for a diligent kids doing some excellent investing. Thus the inequality… Even if you put in the time and try to get ahead, you get with with complex tax forms which you probably have no idea on how to fill out (or even worse your parents will have to do this), or you looks a good chunk of your money to the government.

      This is how inequality through complexity comes into play.

      I guess unless you have the investing experience like I have, you won’t get it. But I will say that it should be a huge concern! I think it’s wrong that kids can go die for the country as a soldier, but don’t get treated fairly with the opportunity to invest in the stock market as an equal to older adults.

      The real kicker is the richer kids don’t care about the kiddie taxes, it only affect the middle and lower classes.