Helping your child begin a lifetime of investments by opening a savings account is a time-honored tradition in many families. While seeding a minor’s savings account with your own money can be a marvelous gesture of generosity, it can also have unforeseen tax consequences for you and your child. Most children’s savings accounts don’t have severe tax implications, though it’s good to understand the law before you open an account for your favorite minor.
Many children open their savings accounts using cash earned through babysitting and mowing lawns. If you help the child get started saving by contributing some of your own money to his account, you may be liable for gift taxes. The Internal Revenue Service allows you to give up to $13,000 each year to any single person without incurring a gift tax, but any amount that exceeds that annual exemption may trigger the gift tax. As of 2012, you have a $5.12 million lifetime credit that can help you dodge that bill if you choose, but the tax man still requires you report the gift. Your unified credit also applies to the amount your estate may exempt from estate taxes after you die, so using your unified credit on gift taxes may expose your estate to larger taxes after your death.
If you’re opening up a savings account, rather than investing in the child’s name, you’ll need to have a healthy balance for it to trigger taxes for your child, but it’s possible. Children who receive $950 or more in interest -- or proceeds from any investment, such as dividends or capital gains -- must usually file a tax return and pay taxes on their earnings. If your child’s only revenue is interest, dividends and mutual-fund growth, you can skip filing for her, and include the income on your own return, but it’s taxed at your regular rate.
The Kiddie Tax
Because the IRS assesses taxes against children’s earnings based on the child’s income for the year, most children who pay taxes pay at a lower rate than their parents do. To prevent parents from socking away investments in their children’s name, the IRS’ “kiddie tax” taxes all children’s investment earnings above $1,900 at the same rate as their parents. Again, your kid will have to be commanding some serious savings account balances to trigger this tax, but it may be on the radar if the child holds investments as well.
If you’re primarily concerned with helping a child pay for his education, a 529 plan offers a few tax advantages. Contributions you make to a 529 in the name of a child are exempt from the gift tax, so you can give more than $13,000 without worrying about tax consequences. Because states administer 529 plans, you can’t deduct the contribution from your federal taxes, but you may be able claim the contribution on your state income tax. Because state laws and rules of each 529 plan differ, consult your state’s department of revenue and the fund administrator to see if you qualify.
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