investing under kid's name to save tax. is it viable?

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hindex
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investing under kid's name to save tax. is it viable?

Post by hindex » Tue Dec 04, 2018 2:38 pm

This might be a dumb question but I can't resist the temptation to ask: is it viable to invest under one's kid's name to avoid tax on capital gains and interests / dividends?

Let's suppose we have a new-born can we open a brokerage account under his/her name and invest in VTSAX (total stock market) or VBTLX (total bond market) to save on tax? Suppose we give him/her $30,000 each year (max tax-free gifting amount) and invest in VTSAX/VBTLX until he/she is 6 years old. Then we start to withdraw $15,000 each year from his/her account to gift them back to us (again, tax-free) until he/she is 18 years old. Then whatever is left in his/her account, we leave it there for the kid. It's like giving the kid interest-free loan to invest and the little one gets to keep the gains. I know there's this thing called kiddie tax rules, but even with that this approach should still save some tax.

Another related but different question is can we set up Roth IRA for the kid and contribute the max ($5,500) per year? I know that one can only contribute *earned* income to IRA, but what prevents a parent from employing her kid? Say, the parent pays $100 to the kid for one smile, maximum $5,500. Is that possible? Any hidden tax / legal issues there?

Thank you!

pdavi21
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Re: investing under kid's name to save tax. is it viable?

Post by pdavi21 » Tue Dec 04, 2018 2:44 pm

Why wouldn't you have to claim their investment income on your 1040?

Only person who can contribute to an IRA without earned income is a non-working spouse.
Earned Income means a contribution to line 7 on form 1040.
ROTH contributions must be below earned income for each person (except non-working spouse).

runner540
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Re: investing under kid's name to save tax. is it viable?

Post by runner540 » Tue Dec 04, 2018 2:45 pm

This is not a new idea and you can't use your kids to evade taxes. I suggest reading about "kiddie" tax and UTMA on the wiki https://www.bogleheads.org/wiki/Kiddie_tax

https://www.bogleheads.org/wiki/Uniform ... Minors_Act

RickBoglehead
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Re: investing under kid's name to save tax. is it viable?

Post by RickBoglehead » Tue Dec 04, 2018 2:49 pm

Yeah, nothing dodgy about paying for smiles, that's bonafide income. Brokerage account requires you to be 18...

The OP might want to look into legitimate ways to plan for a child's future - 529 accounts for college, custodial accounts for brokerage (UGMA, UTMA), trusts, etc.

There are many ways to legitimately finance a child's future as Runner540 posted while I was typing.

Gill
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Re: investing under kid's name to save tax. is it viable?

Post by Gill » Tue Dec 04, 2018 2:51 pm

Tell me how an infant can make $15,000 gifts to his parents. Also, as has been pointed out, you need to review the Kiddie Tax as well as the requirements to have your baby as a legitimate employee. This has been beaten to death and it ain't gonna work.
Gill

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Alexa9
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Re: investing under kid's name to save tax. is it viable?

Post by Alexa9 » Tue Dec 04, 2018 3:01 pm

It is possible although probably not recommended by the IRS. https://www.babycenter.com/404_will-mak ... t_14446.bc
The IRA is out of the question unless you have a family business that they can legitimately work at. I wouldn't try to game the system too much.

hindex
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Re: investing under kid's name to save tax. is it viable?

Post by hindex » Tue Dec 04, 2018 3:05 pm

Thanks all! As long as people here have a consensus that this is not gonna work, I wouldn't waste time trying. Thank you!

Another question: is it OK if we buy $10,000 I-bond every year for the kid? We have an affiliate TreasuryDirect account for the kid and we already maxed out the limit for ourselves.
And can we take out the I-bond (after 1 year / 5 years depending on the situation) from the kid's account without running into tax/legal issues?

Gill
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Re: investing under kid's name to save tax. is it viable?

Post by Gill » Tue Dec 04, 2018 3:12 pm

hindex wrote:
Tue Dec 04, 2018 3:05 pm
And can we take out the I-bond (after 1 year / 5 years depending on the situation) from the kid's account without running into tax/legal issues?
Assuming you hold the bond under your state's UGMA or UTMA provisions, once you put the funds or the bond in the child's name it belongs to the child and you have no right to take it back except to be used for nonsupport expenses of the child. You can transfer it to another asset in the name of the UGMA but you can't appropriate the funds for yourself.
Gill

megabad
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Re: investing under kid's name to save tax. is it viable?

Post by megabad » Tue Dec 04, 2018 3:22 pm

Gill wrote:
Tue Dec 04, 2018 3:12 pm
hindex wrote:
Tue Dec 04, 2018 3:05 pm
And can we take out the I-bond (after 1 year / 5 years depending on the situation) from the kid's account without running into tax/legal issues?
Assuming you hold the bond under your state's UGMA or UTMA provisions, once you put the funds or the bond in the child's name it belongs to the child and you have no right to take it back except to be used for nonsupport expenses of the child. You can transfer it to another asset in the name of the UGMA but you can't appropriate the funds for yourself.
Gill
Not just if you hold in UGMA or UTMA. A minor linked TD account requires the custodian to be a fiduciary acting for child. Child own's the assets, taxes will be handled in a manner consistent with child's tax filing. If you do not act in the best interest of the child, you can be held liable. If you do not file child's taxes correctly, you can be held liable. I would strongly recommend against fraud, theft, or tax evasion.

Gill
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Re: investing under kid's name to save tax. is it viable?

Post by Gill » Tue Dec 04, 2018 3:30 pm

megabad wrote:
Tue Dec 04, 2018 3:22 pm
Not just if you hold in UGMA or UTMA. A minor linked TD account requires the custodian to be a fiduciary acting for child. Child own's the assets, taxes will be handled in a manner consistent with child's tax filing. If you do not act in the best interest of the child, you can be held liable. If you do not file child's taxes correctly, you can be held liable. I would strongly recommend against fraud, theft, or tax evasion.
What do you mean by a "minor linked TD account"? You don't mean TOD, right? I assume this is when the account is in the name of the minor but linked to that of an adult. If that is the case you're certainly correct. I guess I didn't know an account could be in the name of an infant without using UGMA or UTMA.
Gill

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HueyLD
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Re: investing under kid's name to save tax. is it viable?

Post by HueyLD » Tue Dec 04, 2018 5:38 pm

According to the TD:


"What is a Minor account?

A Minor account is a custodial account that a parent, natural guardian, or person providing chief support establishes for a child under the age of 18. You, as the custodian, may purchase, redeem, receive gift deliveries, and perform other transactions within the account on behalf of the minor. When the child reaches age 18 and establishes a TreasuryDirect account, you may de-link the securities into the child's account. De-linking refers to moving the Linked account's securities to a Primary TreasuryDirect account. If you choose to continue to maintain the account once the minor reaches age 18, you are restricted from performing nearly all transactions; however, you may continue to purchase securities on the child's behalf. Minor accounts are not available in entity.

What does de-linking an account mean?

The only Linked account that TreasuryDirect customers can de-link is the Minor account. De-linking refers to moving the Linked account's securities to a Primary TreasuryDirect account. When the child reaches age 18 and establishes a TreasuryDirect account, you may de-link the securities into the child's account. If you choose to continue to maintain the account once the child reaches age 18, you are restricted from performing nearly all transactions; however, you may continue to purchase securities on the child's behalf. De-linking is not available in entity accounts."

Treasury has its own rules on minor accounts.

Grt2bOutdoors
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Re: investing under kid's name to save tax. is it viable?

Post by Grt2bOutdoors » Tue Dec 04, 2018 5:42 pm

hindex wrote:
Tue Dec 04, 2018 3:05 pm
Thanks all! As long as people here have a consensus that this is not gonna work, I wouldn't waste time trying. Thank you!

Another question: is it OK if we buy $10,000 I-bond every year for the kid? We have an affiliate TreasuryDirect account for the kid and we already maxed out the limit for ourselves.
And can we take out the I-bond (after 1 year / 5 years depending on the situation) from the kid's account without running into tax/legal issues?
This is NOT permissible! Similar to the above, a child’s account at Treasury Direct is a form of UTMA - purchases made for minor are considered completed gifts. Yes, you can purchase bonds in behalf of child, the money belongs to the children. If you make withdrawals you may or may not get questioned by IRS on what the proceeds were used for. You can’t use the money for general support that you as a parent are responsible for. www.fairmark.com - search for UTMAs and UTMA regret
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

hindex
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Re: investing under kid's name to save tax. is it viable?

Post by hindex » Tue Dec 04, 2018 10:17 pm

Thanks all! I'm glad that I asked here before actually doing anything. After considering the information and advice presented here, I decide not to invest anything under the kid's name at all - not even I-bonds. Should I delete the linked TreasuryDirect account just in case I use it by mistake?

EddyB
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Re: investing under kid's name to save tax. is it viable?

Post by EddyB » Wed Dec 05, 2018 8:42 am

Grt2bOutdoors wrote:
Tue Dec 04, 2018 5:42 pm
You can’t use the money for general support that you as a parent are responsible for. www.fairmark.com - search for UTMAs and UTMA regret
FYI, that site seems to contradict you: “Many people have the mistaken impression that you can’t use a custodial account for items that a parent is required to provide as support for the child.”

https://fairmark.com/kids-and-college/u ... re-proper/

Grt2bOutdoors
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Re: investing under kid's name to save tax. is it viable?

Post by Grt2bOutdoors » Wed Dec 05, 2018 8:57 am

EddyB wrote:
Wed Dec 05, 2018 8:42 am
Grt2bOutdoors wrote:
Tue Dec 04, 2018 5:42 pm
You can’t use the money for general support that you as a parent are responsible for. www.fairmark.com - search for UTMAs and UTMA regret
FYI, that site seems to contradict you: “Many people have the mistaken impression that you can’t use a custodial account for items that a parent is required to provide as support for the child.”

https://fairmark.com/kids-and-college/u ... re-proper/
If you’re going to quote one section of the site, don’t you think you ought to quote the other section that discusses the Internal Revenue Services interpretation on the use of these accounts and how spending in “support” of said child is subject to taxation that is not related to any interest or dividend income or capital gains earned but taxable on the amount withdrawn from the account to be used to support the minor? There is further discussion about interpretation of what is proper expenditures and what crosses the line.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

EddyB
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Re: investing under kid's name to save tax. is it viable?

Post by EddyB » Wed Dec 05, 2018 9:27 am

Grt2bOutdoors wrote:
Wed Dec 05, 2018 8:57 am
EddyB wrote:
Wed Dec 05, 2018 8:42 am
Grt2bOutdoors wrote:
Tue Dec 04, 2018 5:42 pm
You can’t use the money for general support that you as a parent are responsible for. www.fairmark.com - search for UTMAs and UTMA regret
FYI, that site seems to contradict you: “Many people have the mistaken impression that you can’t use a custodial account for items that a parent is required to provide as support for the child.”

https://fairmark.com/kids-and-college/u ... re-proper/
If you’re going to quote one section of the site, don’t you think you ought to quote the other section that discusses the Internal Revenue Services interpretation on the use of these accounts and how spending in “support” of said child is subject to taxation that is not related to any interest or dividend income or capital gains earned but taxable on the amount withdrawn from the account to be used to support the minor? There is further discussion about interpretation of what is proper expenditures and what crosses the line.
Like where it says “It’s a gross exaggeration to suggest that these rulings mean you can’t use a custodial account in this way”?

I did read the whole thing and concluded that there were potential concerns about nuanced implications of using UTMA funds for required support, but that the site strongly implied those concerns were exaggerated (because it’s not clear whether the tax laws apply, it’s not clear what would be considered required parental support, and other reasons). Clearly your statement was wrong, in that site’s summary view. Don’t blame me.

The site goes on to say:

“IRS rulings on custodial accounts create a concern that if the account is used for expenses that are within the parents’ support obligation, then the parents may have to pay additional tax. It’s a gross exaggeration to suggest that these rulings mean you can’t use a custodial account in this way, or even that you shouldn’t use a custodial account in this way. The rulings do not in any way imply that it is improper to use custodial money for the minor’s support. They simply provide a tax rule that may apply when this happens. In most cases, the tax rule will not be terribly costly. Furthermore, as explained later, there is some question as to whether the rule even applies to custodial accounts under the Uniform Transfers to Minors Act.”

Edited to add that the site’s statement about even the potential income tax issue is very different from what you describe above: “This rule does not create any additional income that didn’t exist before. It merely tells us who has to pay tax on the income generated by the custodial account.”

The example provided is:

“Example: You use $10,000 from a custodial account to pay for items that are within your support obligation. The only income in the account that year was $500 of interest income. The result is that the parent has to pay tax on $500 that otherwise would have been reported as the child’s income.”

Grt2bOutdoors
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Re: investing under kid's name to save tax. is it viable?

Post by Grt2bOutdoors » Wed Dec 05, 2018 1:19 pm

EddyB wrote:
Wed Dec 05, 2018 9:27 am
Grt2bOutdoors wrote:
Wed Dec 05, 2018 8:57 am
EddyB wrote:
Wed Dec 05, 2018 8:42 am
Grt2bOutdoors wrote:
Tue Dec 04, 2018 5:42 pm
You can’t use the money for general support that you as a parent are responsible for. www.fairmark.com - search for UTMAs and UTMA regret
FYI, that site seems to contradict you: “Many people have the mistaken impression that you can’t use a custodial account for items that a parent is required to provide as support for the child.”

https://fairmark.com/kids-and-college/u ... re-proper/
If you’re going to quote one section of the site, don’t you think you ought to quote the other section that discusses the Internal Revenue Services interpretation on the use of these accounts and how spending in “support” of said child is subject to taxation that is not related to any interest or dividend income or capital gains earned but taxable on the amount withdrawn from the account to be used to support the minor? There is further discussion about interpretation of what is proper expenditures and what crosses the line.
Like where it says “It’s a gross exaggeration to suggest that these rulings mean you can’t use a custodial account in this way”?

I did read the whole thing and concluded that there were potential concerns about nuanced implications of using UTMA funds for required support, but that the site strongly implied those concerns were exaggerated (because it’s not clear whether the tax laws apply, it’s not clear what would be considered required parental support, and other reasons). Clearly your statement was wrong, in that site’s summary view. Don’t blame me.

The site goes on to say:

“IRS rulings on custodial accounts create a concern that if the account is used for expenses that are within the parents’ support obligation, then the parents may have to pay additional tax. It’s a gross exaggeration to suggest that these rulings mean you can’t use a custodial account in this way, or even that you shouldn’t use a custodial account in this way. The rulings do not in any way imply that it is improper to use custodial money for the minor’s support. They simply provide a tax rule that may apply when this happens. In most cases, the tax rule will not be terribly costly. Furthermore, as explained later, there is some question as to whether the rule even applies to custodial accounts under the Uniform Transfers to Minors Act.”

Edited to add that the site’s statement about even the potential income tax issue is very different from what you describe above: “This rule does not create any additional income that didn’t exist before. It merely tells us who has to pay tax on the income generated by the custodial account.”

The example provided is:

“Example: You use $10,000 from a custodial account to pay for items that are within your support obligation. The only income in the account that year was $500 of interest income. The result is that the parent has to pay tax on $500 that otherwise would have been reported as the child’s income.”
Given the OP's thread name, you've answered the question - is it viable method to save tax? The answer above suggests no as the parent is responsible to pay the tax otherwise reported as the child's income.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

EddyB
Posts: 565
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Re: investing under kid's name to save tax. is it viable?

Post by EddyB » Wed Dec 05, 2018 6:05 pm

Grt2bOutdoors wrote:
Wed Dec 05, 2018 1:19 pm
EddyB wrote:
Wed Dec 05, 2018 9:27 am
Grt2bOutdoors wrote:
Wed Dec 05, 2018 8:57 am
EddyB wrote:
Wed Dec 05, 2018 8:42 am
Grt2bOutdoors wrote:
Tue Dec 04, 2018 5:42 pm
You can’t use the money for general support that you as a parent are responsible for. www.fairmark.com - search for UTMAs and UTMA regret
FYI, that site seems to contradict you: “Many people have the mistaken impression that you can’t use a custodial account for items that a parent is required to provide as support for the child.”

https://fairmark.com/kids-and-college/u ... re-proper/
If you’re going to quote one section of the site, don’t you think you ought to quote the other section that discusses the Internal Revenue Services interpretation on the use of these accounts and how spending in “support” of said child is subject to taxation that is not related to any interest or dividend income or capital gains earned but taxable on the amount withdrawn from the account to be used to support the minor? There is further discussion about interpretation of what is proper expenditures and what crosses the line.
Like where it says “It’s a gross exaggeration to suggest that these rulings mean you can’t use a custodial account in this way”?

I did read the whole thing and concluded that there were potential concerns about nuanced implications of using UTMA funds for required support, but that the site strongly implied those concerns were exaggerated (because it’s not clear whether the tax laws apply, it’s not clear what would be considered required parental support, and other reasons). Clearly your statement was wrong, in that site’s summary view. Don’t blame me.

The site goes on to say:

“IRS rulings on custodial accounts create a concern that if the account is used for expenses that are within the parents’ support obligation, then the parents may have to pay additional tax. It’s a gross exaggeration to suggest that these rulings mean you can’t use a custodial account in this way, or even that you shouldn’t use a custodial account in this way. The rulings do not in any way imply that it is improper to use custodial money for the minor’s support. They simply provide a tax rule that may apply when this happens. In most cases, the tax rule will not be terribly costly. Furthermore, as explained later, there is some question as to whether the rule even applies to custodial accounts under the Uniform Transfers to Minors Act.”

Edited to add that the site’s statement about even the potential income tax issue is very different from what you describe above: “This rule does not create any additional income that didn’t exist before. It merely tells us who has to pay tax on the income generated by the custodial account.”

The example provided is:

“Example: You use $10,000 from a custodial account to pay for items that are within your support obligation. The only income in the account that year was $500 of interest income. The result is that the parent has to pay tax on $500 that otherwise would have been reported as the child’s income.”
Given the OP's thread name, you've answered the question - is it viable method to save tax? The answer above suggests no as the parent is responsible to pay the tax otherwise reported as the child's income.
Not at all; the site you pointed to doesn't remotely say that. Certainly there's plenty within what I choose to spend on my children (or choose to support their decision to spend from their own resources) that goes well beyond any parental support obligation.

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