FINANCIAL FOCUS: 'KIDDIE TAX' OFFERS SOME GROWN-UP CONSEQUENCES

This "Financial Focus" column is prepared by Edward Jones Investments, headquartered in St. Louis. Jones includes branches throughout the nation, including Cape Girardeau and Jackson.

Do you think you are paying too many taxes on your investment earnings? If so, you might be tempted to seek a solution. And when you look around, you might just see ... your children.

But is it a good idea to move some of your investment income to your children's names? Before you take such a step, you'd better brush up on the rules of the "kiddie tax."

The kiddie tax permits children younger than 14 to receive $700 in investment income -- from interest, dividends or capital gains -- free of tax. (The Taxpayer Relief Act of 1997 allows for periodic increases in this income cap.) The next $700 is taxed at the child's rate -- typically 15 percent for income and short-term capital gains, and 10 percent for long-term capital gains.

After your child receives $1,400 in investment income, the rest of the earnings will be taxed to your child at your rate, which can be as high as 39.6 percent. Consequently, you cannot gain significant tax advantages by shifting a large amount of your investment dollars to your child's name.

Furthermore, after your child turns 18 or 21 -- the actual age depends on where you live -- you will lose control of the money you gave away, because once an asset is gifted to a minor, it can't be taken back. While you might have intended the money for college, your son or daughter may decide to take a long motorcycle trip around Europe.

In addition, by saving money in your children's names, you could be jeopardizing their ability to receive financial aid. Colleges and universities that receive any federal money are typically required to ask children to contribute 35 percent of their assets for colleges expenses -- compared to less than 6 percent for parents.

A possible benefit

Are there any potential benefits to shifting financial assets into your children's names? There may be -- depending on your individual situation.

For example, if your estate is large enough -- $650,000 in 1999, rising to $1 million over the next several years -- to incur state taxes, then you may be able to reduce your estate tax liability and help your future heirs by giving away some assets to your children while you are alive. You and your spouse can each make annual tax-free gifts of up to $10,000 to any number of people you choose. (Starting in 1999, this yearly gift-tax exclusion will be adjusted for inflation.)

If you give an actual security, such as a stock, to your children they will be responsible for any capital gains taxes. If you sell the security while it's in your name, so that you can give cash, you will most likely want to increase your federal and state tax quarterly estimates so you won't incur underpayment penalties.

See your tax adviser

There are many issues involved with the concept of gifting assets and shifting investment income to your children. So, before you take action, you'll want to make one important call -- to your tax adviser.

The Southeast Missourian does not recommend that readers buy or sell stocks featured in this column, which is provided for informational purposes only.