gift, part-sale transaction - that is, the seller's gain on the initial sale and the buyer's gain on a subsequent sale. The proposal may create administrative difficulties when property is hard to value. Under present law, the purchase price (rather than the fair market value) generally determines the tax treatment of the transferor or the acquirer's basis in the property acquired if the acquirer is not a charity. For example, if property with a basis of $50 is transferred for $100 consideration and is later determined to have been worth $200, the transferor's taxable gain of $50 and the transferee's basis ($100) will not be affected. Under the proposal, however, the taxpayer may have reported gain of $50 on the transfer even though he or she should have reported gain of $75, and the transferee's basis will be adjusted to $125 from $100. Ultimately, the administrative concerns potentially presented by the proposal as applied to property that is not readily valued must be weighed against the advantage of taxing a part-gift, part-sale transaction correctly and not permitting similar transactions to have different tax consequences. If administrative problems are of sufficient concern, the proposal might be modified to apply only to readily valued property such as publicly traded stock. H. Simplify Taxation of Minor Children (sec. 1) Present Law Overview In general, children are subject to the same income tax filing requirements and tax rules as other taxpayers, including those applicable to a taxpayer who may be claimed as a dependent by another taxpayer. For children under age 14, net unearned income (generally investment income that exceeds a certain amount) is taxed at the parent's rate if the parent's rate is higher than the child's. This is commonly referred to as the "kiddie tax." In limited circumstances, generally when a child is under 14 and his or her only income is dividends and interest within a certain range, a parent may elect to include the child's unearned income on the parent's return. The application of the kiddie tax may increase (but will not decrease) the amount of tax to be paid on the child's income. The parental election may cause the aggregate tax to be paid on the parent's and child's income to be higher than if the parent and child filed separate returns. Filing requirements for children An unmarried individual eligible to be claimed as a dependent on another taxpayer's return generally must file an individual income tax return if he or she has: (1) earned income over $5,000 (for 2005) and no unearned income; (2) unearned income over the minimum standard deduction amount for dependents ($800 in 2005) and no earned income; or (3) both earned income and unearned income totaling more than the smaller of (a) $5,000 (for 2005) or (b) the larger of (i) $800 (for 2005), or (ii) earned income plus $250.129 Thus, if a dependent child has less than $800 in gross income, the child does not have to file an individual income tax return for 2005.130 A child who cannot be claimed as a dependent on another person's tax return is subject to the generally applicable filing requirements. That is, such an individual generally must file a return if the individual's gross income exceeds the sum of the standard deduction and the personal exemption amounts applicable to the individual. 129 Sec. 6012(a)(1)(C). Other filing requirements apply to dependents who are married, elderly, or blind. See Internal Revenue Service, Publication 929, Tax Rules for Children and Dependents (2004), at 2, Table 1. 130 A taxpayer generally need not file a return if he or she has gross income in an amount less than the standard deduction (and, if allowable to the taxpayer, the personal exemption amount). An individual who may be claimed as a dependent of another taxpayer is not eligible to claim the personal exemption for himself or herself. Sec. 151(d)(2). For taxable years beginning in 2005, the standard deduction amount for an individual who may be claimed as a dependent by another taxpayer may not exceed the greater of $800 or the sum of $250 and the individual's earned income. Taxation of unearned income of children under 14 131 Special rules apply to the unearned income of a child who is under age 14. The kiddie tax applies if: (1) the child has not reached the age of 14 by the close of the taxable year; (2) the child's unearned income was more than $1,600 (for 2005); and (3) the child is required to file a return for the year. 132 For these purposes, unearned income is income other than wages, salaries, professional fees, or other amounts received as compensation for personal services actually rendered. 132 For children under age 14, net unearned income (for 2005, generally unearned income over $1,600) is taxed at the parent's rate if the parent's rate is higher than the child's rate. The remainder of a child's taxable income (i.e., earned income, plus unearned income up to $1,600 (for 2005), less the child's standard deduction) is taxed at the child's rates, regardless of whether the kiddie tax applies to the child. In general, a child is eligible to use the preferential tax rates for qualified dividends and capital gains. 133 The kiddie tax applies regardless of the source of the property generating the income or when the property that gave rise to the income was transferred to or otherwise acquired by the child. Thus, for example, the kiddie tax may apply to income from property acquired by the child with compensation derived from the child's personal services, or from property given to the child by someone other than the child's parent. The kiddie tax applies regardless of whether the child may be claimed as a dependent on the parent's return. The kiddie tax is calculated by computing the "allocable parental tax." This involves adding the net unearned income of the child to the parent's income and then applying the parent's tax rate. A child's "net unearned income" is the child's unearned income less the sum of (1) the minimum standard deduction allowed to dependents ($800 for 2005), and (2) the greater of (a) such minimum standard deduction amount or (b) the amount of allowable itemized deductions that are directly connected with the production of the unearned income. 134 A child's net unearned income cannot exceed the child's taxable income. The allocable parental tax equals the hypothetical increase in tax to the parent that results from adding the child's net unearned income to the parent's taxable income. If a parent has more than one child subject to the kiddie tax, the net unearned income of all children is combined, and a single kiddie tax is calculated. Each child is then allocated a proportionate share of the hypothetical increase, based upon the child's net unearned income relative to the aggregate net unearned income of all of the parent's children subject to the tax. Special rules apply to determine which parent's tax return and rate is used to calculate the kiddie tax. If the parents file a joint return, the allocable parental tax is calculated using the income reported on the joint return. In the case of parents who are married but file separate returns, the allocable parental tax is calculated using the income of the parent with the greater amount of taxable income. In the case of unmarried parents, the child's custodial parent is the parent whose taxable income is taken into account in determining the child's liability. If the custodial parent has remarried, the stepparent is treated as the child's other parent. Thus, if the custodial parent and stepparent file a joint return, the kiddie tax is calculated using that joint return. If the custodial parent and stepparent file separate returns, the return of the one with the greater taxable income is used. If the parents are unmarried but lived together all year, the return of the parent with the greater taxable income is used. 135 Unless the parent elects to include the child's income on the parent's return (as described below) the child files a separate return to report the child's income,136 and items on the parent's return are not affected by the child's income. The total tax due from a child is the greater of: (1) the sum of (a) the tax payable by the child on the child's earned income plus (b) the allocable parental tax on the child's unearned income, or (2) the tax on the child's income without regard to the kiddie tax provisions. Thus, application of the kiddie tax will not reduce (but in many cases will increase) a child's tax liability. A child's qualifying dividends and capital gains are subject to the preferential tax rates for such income. Such dividends and capital gains are allocated between the child and the parent by allocating the $1,600 (for 2005) between such dividends and gains and the child's other investment income. 138 137 Example.-For 2005, a child who is age 13 has wages of $1,550, and total unearned income consisting of capital gains, dividends, and interest, of $2,800. The child may be claimed as a dependent on her parents' joint return. The child's adjusted gross income is $4,350, 135 Sec. 1(g)(5); Internal Revenue Service, Publication 929, Tax Rules for Children and Dependents (2004), at 6. 136 The child must attach to the return Form 8615, Tax for Children Under Age 14 With Investment Income of More Than $1,600 (2004). 137 IRS Publication 929, Tax Rules for Children and Dependents (2004), at 8 (referring to Instructions to Form 8814, Child's Qualified Dividends and Capital Gain Distributions Worksheet, to divide the $1,600 base amount between the child's qualified dividends, capital gain distributions, and other interest and dividend income). 138 This example is based on the illustrated example contained in IRS Publication 929, Tax Rules for Children and Dependents (2004) at 16-23. The amount of unearned income of a minor child taxed at the parent's rates is the same for both 2004 and 2005 (i.e., over $1,600). standard deduction is $1,800 (i.e., $1,550 of earned income plus $250), and taxable income is $2,550. Because the child has unearned income for 2005 exceeding $1,600, the child is subject to the kiddie tax provisions. The child's net unearned income of $1,200 (i.e., $2,800 less $1,600) is subject to tax at the parents' rates. The remaining $1,350 of the child's taxable income (i.e., the excess of the child's earned income, and unearned income up to $1,600, over the standard deduction amount) is taxed at the child's rates. The child's capital gains and dividends are subject to the preferential tax rate for capital gains and qualifying dividends. Because the child has income other than dividends and interest, the parental election (described below) may not be made to include the child's unearned income on the parents' return. Parental election to include child's dividends and interest on parent's return Under certain circumstances, a parent may elect to report a child's dividends and interest on the parent's return. If the election is made, the child is treated as having no income for the year and the child does not have to file a return. The parent makes the election on Form 8814, "Parents' Election To Report Child's Interest and Dividends." The requirements for the parent's election are that: the child has gross income only from interest and dividends (including capital gains distributions and Alaska Permanent Fund Dividends);" 139 such income is more than the minimum standard deduction amount for dependents ($800 in 2005) and less than 10 times that amount ($8,000 in 2005); (1) (2) (3) (4) no backup withholding occurred; and (5) the child is required to file a return if the parent does not make the election. no estimated tax payments for the year were made in the child's name and Only the parent whose return must be used when calculating the kiddie tax may make the election. The parent includes in income the child's gross income in excess of twice the minimum standard deduction amount for dependents (i.e., the child's gross income in excess of $1,600 for 2005). This amount is taxed at the parent's rate. The parent also must report an additional tax liability equal to the lesser of: (1) $80 (in 2005); or (2) 10 percent of the child's gross income (including qualifying dividends and capital gain distributions) exceeding the child's standard deduction ($800 in 2005). Including the child's income on the parent's return can affect the parent's deductions and credits that are based on adjusted gross income, as well as income-based phaseouts, limitations, and floors. In addition, certain deductions that the child would have been entitled to take on 140 139 Id. at 7. 140 Id. |