Finance Questions

Archive for the ‘Kiddie Tax’ Category

When opening an UGMA account, people often don’t think about taking money from their UGMA account. But, after a few years, the most popular questions concerning UGMA accounts concern borrowing money from UGMA and how are UGMA account withdrawals taxed.

At some point in time, taking money from your UGMA account may be necessary. If you have multiple UGMA accounts, you will need to decide which UGMA account you are taking withdrawals from.

How are UGMA Account Withdrawals Taxed?

All UGMA account withdrawals are taxed. Depending on the age of the minor whose name and social security number is listed on the UGMA account, different tax rates for the UGMA account withdrawals apply. When withdrawals are taken from an UGMA account, the minor must file an annual income tax return.

The minor’s social security number is on the UGMA account for him or her. The minor must pay taxes on any income exceeding a certain tax limit that year produced by the UGMA account withdrawals at the parent’s top marginal tax rate until the minor reached the age of 14. UGMA account withdrawals taxation exclusions are available and they are indexed for inflation.

Taking money from my UGMA

If you are taking money from your UGMA account and you are 14 or above, then you must pay income taxes to the IRS on your UGMA account withdrawals at you tax rate. You are the UGMA account beneficiary and you are responsible for paying taxes. In most states, the custodian of the UGMA account is responsible to ensure that taxes are paid. So, when borrowing money from your UGMA account, think about how UGMA account withdrawals are taxed.

UGMA stands for Uniform Gift for Minors.

UTMA stands for Uniform Transfers to Minors.

What are the tax consequences of setting up a custodial account?

The assets of an UGMA / UTMA account are the minor’s property outright. Any gifts made to an UGMA / UTMA account are irrevocable and the donor relinquishes all rights to the property.
Although a designated custodian manages the property while the minor is under the applicable age of majority, legal title to the assets belongs to the minor. As soon as the minor reaches the designated distribution age, at which the UGMA or UTMA specifies that custodianship terminate, the assets in the custodial account must be distributed or transferred to an account in the single name of the minor.
There is no limit on the maximum contribution that may be made to a custodial account. To the extent a donor contributes more than $11,000 ($22,000 for a married couple, each giving $11,000) to a custodial account in any one year the donor is required to file a gift tax return even if no gift tax is due.
Since the child is the owner of the assets in the custodial account, all the income tax consequences belong to the child. How the income generated in the custodial account will be taxed and reported to the IRS depends upon the age of the child and the child’s other sources of income.

How is a child’s capital losses treated for tax purposes?

Any capital losses in an UGMA / UTMA account belong to the child, not the parents. The parents cannot report the capital losses on their tax return or use the losses to offset their own capital gains.
Generally, if the child’s has ordinary income of $3,800 or more, the child will be able to use capital losses (up to a maximum of $3,000) to offset this income. Capital losses in excess of $3,000 will be carried over the next year.
Figuring a child’s capital loss carryover:

The amount the child’s capital loss carryover is the amount of the child’s total net capital loss that is more than the lesser of:

1. The child’s allowable capital loss deduction for the year, or
2. The child’s taxable income increased by the child’s allowable capital loss deduction for the year.

If deductions are more than income for the tax year, use your negative taxable income in computing the amount in item (2).
Note: If the child has a capital loss carryover, it is recommended that a return be filed even if no return is required to be filed.
Example: For 2005, a child had $1,000 of interest income and a $5,000 capital loss from the sale of stock. The child’s taxable income is ($2,800) computed as follows:

To figure any capital loss carryover to 2005 use the Capital Loss Carryover Worksheet in the 2004 instructions for Schedule D. To figure the carryover now, see IRS Publication 550, Investment Income and Expenses.

When is a dependent child required to file a federal income tax return?

A dependent child must file a tax return if any one of the following applies: 

• Unearned income was more than $850 (for 2006) or
• Earned income was more than $5,150 ($4,850 previously) or
• Gross income (total unearned and earned income) was more than the larger of:
  1. $850 ( for 2006) or
  2. Earned income was more than $5,150 ($4,850 previously) plus $300.

A dependent child that has gross income (unearned plus earned income) of $850 (for 2006) or less will not be taxed on that amount and does not have to file a tax return.

Who is responsible for filing the dependent child ’s tax return and paying the tax?

If a dependent child cannot file his or her own return for any reason, such as age, the child’s parent or guardian is responsible for filing a return on his or her behalf. If the child does not pay the tax due on this income, the parent may be liable for the tax.
A parent may take money out of the child’s UGMA / UTMA to pay the child’s tax liability. If the parent pays the tax out of the parent’s assets, the payment is considered an additional gift to the child.

How is a dependent child ’s income taxed?

Dependent children age 14 and over are taxed at the rates for Single taxpayers. 
Standard Deduction: A dependent child is entitled to a standard deduction of: 

The higher of: 

• $850 (for 2006) or,
• $300 plus earned income (wages, salary, tips, etc.) up to a maximum of $5,150.

Income in excess of the applicable standard deduction is subject to tax. A dependent child is not entitled to a personal exemption. 
Child age 14 or over (Kiddie Tax does not apply): 
All income in excess of the standard deduction is taxed at the child’s tax rate (single taxpayer). 
Child under age 14:

Note: If the dependent child ’s gross income is below the standard deduction there is no tax due and no federal income tax return is required to be filed.