During the period from birth through age 23, a child’s tax capacity is limited by the Kiddie Tax. The Kiddie Tax is applied to the investment income (earned income is not subject to the Kiddie Tax rules) of a child under age 24 which exceeds $2,100. The investment income is taxed at the parents investment tax rate of 15% for capital gains, or 0% for the child.
Instead of shifting investment income to the child, the parents shifted business income of $5,000 to their child in the form of business wages. Since the parents income was taxed at the 30% tax bracket the income reduction may decrease their income taxes by $1,500 ($5,000 x 30%). Since the child’s taxable income was taxed at the 0% tax bracket, there may be no tax on the income. Therefore, because of the income shifting, the total family tax savings may be $1,500.
If you are in a combined (federal, self-employment, and state) tax bracket of 30%, you could reduce your taxes up to $300 for every $1,000 of income reduction by shifting income to a child in a low tax bracket.