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Author: jayguo Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 120812  
Subject: tax question for child Date: 3/11/2001 11:59 AM
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I have a two-month old baby daughter and several questions about tax. By reading "The Kiddie Tax" as well as other articles in Tax Center, I was advised to buy $700 Series EE saving bonds for my baby (because it is tax free for her with unearned income less than $700) per year until she is 14 years old. I also want to open an Education IRA for her with $500 per year.

My questions are
1. What is Series EE saving bonds?
2. Where can I purchase them?
3. Is $500 (toward Edu. IRA) an unearned income for her? In other words, is her total unearned income $1200 ($700 + $500)?
4. Is UGMA a better choice than Edu. IRA? I don't mind it is a custodian accounts.
5. I plan to 'hire' her when she is old enough to do some chores, so that she can open an Roth IRA. Wondering how to figure out the tax rate for her? More specifically, will she use 1040 form and the same tax table as ours?
6. I want to do as much as I can to make a contribution to her as well as lower the tax burden in terms of the whole family. Is anything missed here in my plan?

Thanks in advance.
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Author: CPAScott Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48159 of 120812
Subject: Re: tax question for child Date: 3/11/2001 2:01 PM
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Here are the answers to your questions about Series EE bonds. I'll let the other posters deal with your other questions.

Series EE bonds are issued by the United States Treasury Department, and represent a loan by you to the U.S. government. Series EE bonds usually have 30-year terms. There is a limit of $15,000 of face value that can be purchased by any one person in a given year.

Series EE bonds can be purchased at any financial institution (bank, credit union, etc.) that serves as a savings bond agent. Most major banks offer savings bonds.

There is a tax advantage to using Series EE bonds for education expenses, as some or all of the income on the bonds may be exlcuded for tax purposes at the time of redemption. For more information on this topic, see IRS Publication 550, Investment Income and Expenses and IRS Form 8815, Exclusion of Interest from Series EE U.S. Savings Bonds Issued After 1989. Both can be downloaded from the IRS' website at www.irs.ustreas.gov.

The following advice is provided by the Treasury Department on its website (www.ustreas.gov) regarding Series EE bonds and tax advantages for children:

"Individuals with modified adjusted gross incomes that are likely to exceed the limits of the interest exclusion program can still receive tax advantages when saving for a child's future education. It also offers all individuals a way to save for any future need a child might have. To secure this tax advantage:

*Buy bonds in the child's name alone, or with a parent, relative or any other person as beneficiary (not coowner).

*After the first year in which bond purchases have been made (or later), parents may choose to file a Federal income tax return in the child's name (the child will need to have a Social Security number) reporting the entire accumulated accrued interest on all bonds registered to the child. Show on the return that it is being filed with the intent of reporting savings bonds interest annually. Save a copy of the return. In some cases, tax deferral may be more advantageous than this annual reporting method. If bonds are cashed after a child reaches 14 years of age, all deferred interest income will be taxable to the child.

*Under the annual reporting method, no tax will be due until the child has unearned income (interest and dividends) of $600 or more in a single year, and no further returns need to be filed until that annual level has been reached.

*Under the annual reporting method, you will need to file an income tax return for any year in which the child's unearned income exceeds $600 . For children under the age of 14, taxes will be paid at the
parent's rate if the unearned income exceeds $1,200. Once a child has reached 14 years of age, all taxes will be paid at the child's rate.
When the bonds are redeemed, only the most recent year's accrual will have to be reported for tax purposes if the annual reporting method was used. In most cases, little or no tax will have been due over the life of the bonds. It is essential to keep good records."

CPAScott


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Author: rensimer Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48162 of 120812
Subject: Re: tax question for child Date: 3/11/2001 2:55 PM
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Under the annual reporting method, no tax will be due until the child has unearned income (interest and dividends) of $600 or more in a single year, and no further returns need to be filed until that annual level has been reached.

The last year that the unearned income threshhold for having to file a return and pay tax for a child with income from investments only (no earned income) was $600 was 1994; that threshhold in 2000 was $700 and is $750 for 2001.

WTR

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Author: CPAScott Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48165 of 120812
Subject: Re: tax question for child Date: 3/11/2001 4:02 PM
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Ah yes, WTR, thanks for catching that. I didn't proofread what the Treasury Department had written on its site -- I just pulled the section.

CPAScott

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Author: jayguo Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48167 of 120812
Subject: Re: tax question for child Date: 3/11/2001 4:25 PM
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WTR, Thanks for pointing it out. Where did you find the threshold? I looked at Publication 519 and did not find the info. Also, a basic question: If I buy EE bond in my daughter's name. Is the money unearned income for her? Thanks. Jay

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Author: rensimer Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48171 of 120812
Subject: Re: tax question for child Date: 3/11/2001 5:49 PM
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Where did you find the threshold?

1040-ES/V (Estimated Tax for Individuals) instructions, page 2, under the section for the standard deduction amounts for 2001.

If I buy EE bond in my daughter's name, is the money unearned income for her?

Yes.

WTR

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Author: acm4tax Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48193 of 120812
Subject: Re: tax question for child Date: 3/12/2001 1:47 AM
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When weighing how much tax the family will save by putting funds into a UGMA account or some such that actually transfers funds to the child's name, please consider some posisible negative consequences.

If you should get divorced and think you can use these funds to help with child support payments, you will be disappointed. Or worse yet, when the cherib turns 18 and has an angry fight with you, any of those funds that are legally his can be used for cars, concerts, or stereo equipment, drugs or gambling or whatever pleases his little heart.

I opt for complete control of the funds, unless you're in a particular situation where it is imperative that the funds be separated from your assets.

Just some observations of some real horror stories I have seen.

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Author: cfdunton One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48217 of 120812
Subject: Re: tax question for child Date: 3/12/2001 11:34 AM
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This is a very informative string of posts but I want to make sure I understand it before I do it wrong!

If I buy $5,000 in EE bonds in a child's name, does that child have to file a tax return claiming the $5,000 as unearned income?

If I buy a lesser amount, say $750, then the child would not have to file. Right?

The interest on the EE bonds can accumulate until the total has reached $750 and then the child files a tax return claiming all the interest from the previous years on the tax return for that year and indicating that the return is for the purpose of reporting bond interest annually. Right?

So you could buy $750 worth each year for the child and report the interest only when it reaches the $750 limit. Right?

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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48220 of 120812
Subject: Re: tax question for child Date: 3/12/2001 11:46 AM
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cdfunton,

If I buy $5,000 in EE bonds in a child's name, does that child have to file a tax return claiming the $5,000 as unearned income?

No. The principal invested in the bonds is not income, only the interest earned on the bonds.

If I buy a lesser amount, say $750, then the child would not have to file. Right?

Right, but even at $5,000 of bonds, you won't have more than $750 of interest unless EE bonds are now paying 15% annually.

Ira






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Author: rensimer Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48235 of 120812
Subject: Re: tax question for child Date: 3/12/2001 3:15 PM
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If I buy EE bond in my daughter's name, is the money unearned income for her?

I answered yes to this question in a previous post, but from the string of questions being asked, I'm getting the sense that there is still some confusion as to what constitutes the unearned income here. The money being used to buy the EE bonds is a gift to the child, not income of any kind to the child, and not subject to any income taxes. The interest paid on these bonds is unearned income to the child; she can receive up to $750/yr. of interest without filing/paying income tax.

WTR

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48282 of 120812
Subject: Re: tax question for child Date: 3/13/2001 1:56 AM
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The interest on the EE bonds can accumulate until the total has reached $750 and then the child files a tax return claiming all the interest from the previous years on the tax return for that year and indicating that the return is for the purpose of reporting bond interest annually. Right?

Not exactly. You don't accumulate interest from year to year. You look at each year one at a time. The interest from that year is reported on the child's return -- just like yours. If the interest, along with any other unearned income, is less than $750 then no tax is due on that year's return.

Now it is true that the interest you report on the EE bonds will get larger each year, but not because the prior year's interest is being added to the current year's interest. It is simply the way an amortization schedule works.

So you could buy $750 worth each year for the child and report the interest only when it reaches the $750 limit. Right?

The amount you buy each year is immaterial. Once you have spent about $9k to $10k on the bonds (I'm talking purchase price, not maturity value here), the annual interest accrual will be around the $750 figure. Then you'll start paying tax on the interest earnings. And since the interest accruing on the bonds will get somewhat larger each year, you'll then continue to file returns and pay tax each year after that. I'm assuming that the child has no other investments generating interest or dividends.

--Peter

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48283 of 120812
Subject: Re: tax question for child Date: 3/13/2001 2:08 AM
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My questions are
1. What is Series EE saving bonds?
2. Where can I purchase them?


Already answered.

3. Is $500 (toward Edu. IRA) an unearned income for her? In other words, is her total unearned income $1200 ($700 + $500)?

No. As someone else already pointed out, the $500 AND the $700 are gifts to her, not income.

4. Is UGMA a better choice than Edu. IRA? I don't mind it is a custodian accounts.

"Better" in this situation is a judgement call. It depends entirely on how much control you want to exercise over the money as your daughter gets older. In a UGMA account, once she turns 18 (or the age of majority in your state) the money is hers. It can just as easily go for spring break in Florida as for a college education. The funds in an Ed IRA are not as easily spent, and can be controlled by you a bit longer.

5. I plan to 'hire' her when she is old enough to do some chores, so that she can open an Roth IRA. Wondering how to figure out the tax rate for her? More specifically, will she use 1040 form and the same tax table as ours?

By "ours" you are implying a joint return. She would use the single tax schedule rather than the married filing joint schedule. However, while she is under 14, the single rates will apply only to her earned income. Her unearned income (over $1500 currently) will be taxed at YOUR rates.

6. I want to do as much as I can to make a contribution to her as well as lower the tax burden in terms of the whole family. Is anything missed here in my plan?

In general, the maximum tax savings are achieved only when you give the child more control over the funds. So you'll need to balance those two competing forces.

--Peter

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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48292 of 120812
Subject: Re: tax question for child Date: 3/13/2001 9:03 AM
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cdfunton:

The interest on the EE bonds can accumulate until the total has reached $750 and then the child files a tax return claiming all the interest from the previous years on the tax return for that year and indicating that the return is for the purpose of reporting bond interest annually. Right?

ptheland:

Not exactly. You don't accumulate interest from year to year. You look at each year one at a time. The interest from that year is reported on the child's return -- just like yours. If the interest, along with any other unearned income, is less than $750 then no tax is due on that year's return.

me:

Actually, you can accumulate interest from year to year when you invest in EE bonds. See IRS Pub. 550 for details. This is particularly beneficial when you intend to redeem the bonds and use the proceeds for educational expenses. In this case, the accrued interest is excluded from income.

It is also possible to switch from accrual to annual recognition by recognizing all of the to-date accrued interest in the year of switch.

Ira


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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 48374 of 120812
Subject: Re: tax question for child Date: 3/14/2001 3:46 AM
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cdfunton:

The interest on the EE bonds can accumulate until the total has reached $750 and then the child files a tax return claiming all the interest from the previous years on the tax return for that year and indicating that the return is for the purpose of reporting bond interest annually. Right?

ptheland:

Not exactly. You don't accumulate interest from year to year. You look at each year one at a time. The interest from that year is reported on the child's return -- just like yours. If the interest, along with any other unearned income, is less than $750 then no tax is due on that year's return.

ira:

Actually, you can accumulate interest from year to year when you invest in EE bonds. See IRS Pub. 550 for details. This is particularly beneficial when you intend to redeem the bonds and use the proceeds for educational expenses. In this case, the accrued interest is excluded from income.

It is also possible to switch from accrual to annual recognition by recognizing all of the to-date accrued interest in the year of switch.


Thanks, Ira. I'm always learning a little bit more here - especially in areas that I don't see in my practice.

I was reading cdfunton's response as: accumulate interest until it's $750, then report it, then go back to accumulating. After looking at it again, I'm not so sure I read him/her correctly.

--Peter

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