An idea brewing on Capitol Hill could raise the tax rates on capital gains and dividends for your young investors. The proposal has not yet become law, but if it does, here's how it could affect you and your budding business tycoons.
Currently, many investors pay a 15% tax on their long-term capital gains. That applies, for example, to profits on the sale of stock or mutual funds that had been held for more than one year. The same rate applies to most dividends.
For people who fall into the two lowest income tax brackets -- single taxpayers earning less than $31,850 this year and married couples earning less than $63,700 -- the rate drops lower. This year, taxpayers in those lower income tax brackets pay a 5% tax on their long-term capital gains and dividends. In the future, their capital gain and dividend taxes disappear when the tax rate drops to 0% for 2008, 2009, and 2010.
Assuming your kids aren't famous movie actors or models earning lots of income on their own, they probably fall under these lower-income categories. That means capital gains and dividends on any stocks or mutual funds held in their names might be taxed at 5% this year and 0% next year.
Sounds like a pretty good deal, right? In fact, some parents may have moved some of their investments into their children's names to take advantage of these lower rates. Other parents may view these low tax rates as yet another good reason to get their kids interested in investing. You can read more about strategies for shifting your income to family members in lower tax brackets here.
House lawmakers (Republican and Democrat) who oversee the tax laws want to change how these lower rates apply to children and college students. They would make it so that long-term capital gains and dividends earned by anyone under age 19 are taxed at the same rates as their parents.
In other words, many kids couldn't take advantage of the lower rates unless their parents could, too. The same rule, if enacted, would apply to students under age 24. It would not apply to young people who earn half of the income that supports them.
If you've been thinking it may time to sell those shares of Nike, iPod maker Apple, or McDonald's that you purchased as gifts for your children, you might want to keep an eye on this potential change.
As it's currently drafted, the change would apply beginning in January this year. It may have a pretty good chance of becoming law, considering that it has support from both Republicans and Democrats. It's also tied to a bill increasing the minimum wage.
This isn't the only new tax rule afoot when it comes to kids and investment income. Foolish tax guru Roy Lewis recently outlined another change, now in effect, that applies to the "kiddie tax."
Of course, taxes aren't the only thing to think about when making investment decisions or teaching your children about investing. Kids can tap into the power of compounding earnings in a way we older folks cannot. They have lots and lots of time to watch their investments grow.
As a parent, you have plenty of options for how and where to invest on behalf of your kids. The Motley Fool Green Light newsletter recently looked at the different types of accounts you might want to use when investing for and with your children. They even suggested a few kid-friendly investments. You can also get great information from our Teens & Their Money Center.
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