On May 25, 2007, the President signed into law the "Small Business and Work Opportunity Tax Act of 2007" which includes provisions that broaden the reach of the "Kiddie Tax." As a result of the new legislation, the Kiddie Tax may lose its moniker; in addition to minor children, college-age "kids"are potentially subject to the heightened tax on unearned income.

In all, the new provisions, which become effective on January 1, 2008, are slated to harvest over $1.4 billion in revenue from affected taxpayers over the next decade. Since children and parents have the remainder of 2007 before the law takes effect, opportunities still exist to reduce the impact of the revised Kiddie Tax.

In general, the Kiddie Tax dissuades a high income tax-bracket parent from using his or her child's lower tax-bracket. Without the Kiddie tax, a parent could shift investment assets to a child and then have the child pay income tax at his reduced bracket when income is realized. To close this loophole, Congress requires children to use their parent's tax bracket for unearned income in excess of $1,700. Unearned income is typically interest, dividends or capital gains. Earned income, which is income from wages, salaries, professional fees and distributions from qualified disability trusts, is not subject to the Kiddie Tax.

For the remainder of 2007, the Kiddie Tax applies if a child has not reached the age of 18 by the close of the taxable year and either of the child's parents is alive. In other words, the Kiddie Tax, at present, does not apply in the tax year the child turns 18; only those children who are 17 and younger potentially are subject to their parent's tax rates under current law.

The reach of the revised Kiddie Tax has been expanded in two situations. First, the tax treatment applies in the case of a child who has not reached age 19 by the end of the tax year and earns less than half of his support. Second, the provisions apply also if the child is a full-time student, under the age of 24, and earns less than half of his support. A child is considered to earn less than half of his support if his earned income is less than half of the costs required for items such as food, shelter, clothing, medical and dental care, and education. Amounts received as a scholarship for study at an educational organization are not treated as being provided by the child for purposes of the Kiddie Tax. In sum, beginning on January 1, 2008, the Kiddie Tax will apply if:

(1) a child does not turn 18 during the tax year; or
(2) a child does not turn 19 during the tax year and earns less than half his support; or
(3) a child is a full time student, under the age of 24, and earns less than half his support.

The legislation, in application, is targeted at the majority of full-time college students and a handful of graduate students who have unearned income in excess of $1,700 and little earned income from part-time jobs.

Since the recently enacted legislation does not come into effect until 2008, individuals who might be affected by the changes to the Kiddie Tax should consider tax planning to reduce or eliminate the impact of the legislation. Some taxpayers may be able to escape the impact of the revised legislation altogether. For instance, an 18 year-old who is scheduled to enter college next fall could sell stock during 2007, before the legislation takes effect. Prior to the new legislation, such a move would have been inadvisable because, starting in 2008, long-term capital gains rates are scheduled to drop to zero for taxpayers who are in the lowest two ordinary income tax brackets, which are 10% and 15%. The revised Kiddie Tax, however, places the college student- an individual who would normally be in the lowest two tax brackets-in his parent's tax bracket for unearned income over $1,700. The five percent (5%) tax on capital gains in 2007 now becomes preferable to a 15% tax during 2008; our 18 year-old college student nets a 10% tax savings by acting in 2007.

Parents of younger children who cannot escape the modified Kiddie Tax should consider options that will limit exposure to the tax on unearned income. In short, investments that, in the aggregate, produce less than $1,700 in unearned income are preferred. The following investments, for example, are Kiddie Tax friendly: (1) investment in a Section 529 plan, such as Louisiana's START Plan; (2) investment in high-growth, low dividend paying stock; (3) investment in tax-exempt municipal bonds or funds; and (4) investment in non-income producing assets, such as land or interests in closely-held businesses that do not pay dividends.

Any planning, of course, should take into consideration non-Kiddie Tax factors. For instance, a transfer of Kiddie Tax friendly assets to a college student may cause that student to become ineligible for financial aid. State and federal gift tax considerations also remain important since the Kiddie Tax, a part of the income tax regime, operates alongside the transfer tax regimes. Taxpayers, therefore, should obtain competent advice before implementing any of the above strategies.

Since the legislation takes effect at the close of 2007, taxpayers are advised to examine their exposure during the remainder of the current year. Adjusting a child's portfolio in 2007 may result in significant tax savings in 2008.