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So I have a UTMA account for my Daughter at Vanguard. For several years, I've been transferring funds between the S&P index and Total Market index funds while always staying under the standard deduction amount for a dependent ($950 for 2012). AFAIK, staying under that amount meant a return did not need to be filed for her.

I recently discovered that, for 2012, she can have up to $1900 in "unearned" income without paying taxes, but I will have to file a return for her per form 8615: http://www.irs.gov/pub/irs-pdf/f8615.pdf

My question, are there any concerns with transferring between funds to take gains, increase the cost basis and reduce future taxes so long as I keep the unearned income below $1900?

She is 12yo and has no other income.

-murray
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I recently discovered that, for 2012, she can have up to $1900 in "unearned" income without paying taxes

Unlearn that. You're confusing two things: filing requirement (which implies having to pay tax) and the threshold for "kiddie" tax rates. For 2012 if a dependent has nothing but unearned income the standard deduction is $950. Beyond that tax is due.

See the 1040 instructions.

Phil
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You're confusing two things: filing requirement (which implies having to pay tax) and the threshold for "kiddie" tax rates. For 2012 if a dependent has nothing but unearned income the standard deduction is $950. Beyond that tax is due.

According to TurboTax for 2012, you are mistaken.

When I made a fake return for my daughter using the actual gains from her account, I entered a hypothetical fund sale that adjusted her unearned income just below & above $1900.

Below $1900, her tax was calculated using the "Qualified Dividends and Capital Gain Tax Worksheet" which resulted in no taxes.

Above $1900, her tax was calculated using Form 8615 which I linked in my earlier post which clearly subtracts $1900 from unearned income with instructions to stop if zero.

So, if I can deduce the rules, above $1900 of unearned income, her income would be taxed according to form 8615 which I believe is at my tax rate.

Below $1900, her income would be taxed as qualified dividends and long term gains which, since 2007, is 0% for those in the 10% & 15% brackets.

If you don't mind, could you point out where I'm wrong?

Thanks
-murray
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You're confusing two things: filing requirement (which implies having to pay tax) and the threshold for "kiddie" tax rates. For 2012 if a dependent has nothing but unearned income the standard deduction is $950. Beyond that tax is due.

According to TurboTax for 2012, you are mistaken.

When I made a fake return for my daughter using the actual gains from her account, I entered a hypothetical fund sale that adjusted her unearned income just below & above $1900.


My dummy return was interest income, which is not subject to the special rate of zero, so that explains why I show tax and you don't. Sorry for the confusion. So, to sum up:

1. If a dependent has only unearned income the standard deduction for 2012 is $950. Above that amount the dependent must file a return.*

2. At $1900 of unearned income the kiddie tax rules kick in, and the dependent pays at the parent's rate.

3. If the dependent has only long-term cap gains and qualified dividends the dependent will pay zero tax up to $1900 of income even though a return may be required.

4. *In some cases the parent can report the child's income on the parent's return, but I've never been able to figure out why a parent would want to, and it cannot be done if Schedule D is involved.

Phil
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3. If the dependent has only long-term cap gains and qualified dividends the dependent will pay zero tax up to $1900 of income even though a return may be required.

Thanks very much for confirming this for me.

I didn't mention, we have a portion of her funds in a total bond index fund. Would the monthly proceeds from the bond fund be considered interest or qualified dividends? I entered those amounts straight from the 1099 from Vanguard and it appears those are qualified dividends.

-murray
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I didn't mention, we have a portion of her funds in a total bond index fund. Would the monthly proceeds from the bond fund be considered interest or qualified dividends?

I don't find them on the list of so-called dividends, e.g., credit union dividends, which are actually interest. That list is in Pub 550. Also, the pub indicates that they would be reported on a 1099-INT. So I think you're safe.

Phil
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I didn't mention, we have a portion of her funds in a total bond index fund. Would the monthly proceeds from the bond fund be considered interest or qualified dividends?

I would think you want door #3. They are ordinary dividends.

Ira
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Thanks for the responses. I feel confident to move forward and, worst case, we'll pay a small amount of tax, though TT for 2012 indicates that there would be none and the tax law changes should affect this case.

-murray
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I'll agree with Ira, that bond fund dividends are ordinary dividends, not qualified dividends.

TT is probably coming up with the right number here. Those ordinary dividends from the bond fund are taxable, but apparently less than the $950 standard deduction.

As a recap, the first $950 of your child's income is not taxed. The next $950 is taxed at her tax rates. The ordinary tax rate on that part of her income is 10%. So if any of that income is long term capital gains or qualified dividends, it gets a special tax rate of 0%.

Income over that first $1900 will be taxed at your rate.

--Peter
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As a recap, the first $950 of your child's income is not taxed. The next $950 is taxed at her tax rates. The ordinary tax rate on that part of her income is 10%. So if any of that income is long term capital gains or qualified dividends, it gets a special tax rate of 0%.

Indeed, the proceeds from bond fund dividends is only about $150. From the sound of it, if non qualified dividends, interest & short term gains total less than $950, that income will be covered by the exemption, does that sound correct?

-murray
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From the sound of it, if non qualified dividends, interest & short term gains total less than $950, that income will be covered by the exemption, does that sound correct?

Yes.

There's probably some other kinds of income you could include in that list, but they would be far less common than those three.

--Peter
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Yes.

There's probably some other kinds of income you could include in that list, but they would be far less common than those three.


Thanks. I confirmed this by taking a closer look at the Form 1040, Line 44 "Qualified Dividends and Capital Gain Tax Worksheet"; indeed, you add qualified dividends and long term gains and subtract that from the taxable income and, if less than zero, you pay not tax in this case.

So back to my original question, is there any good reason to not shift between funds in my daughter's UTMA to take long term gains? This appears to be a good strategy to reduce future taxable income by 10's of thousands. Other than filing another simple tax return, it seems like a no brainer.

-murray
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So back to my original question, is there any good reason to not shift between funds in my daughter's UTMA to take long term gains? This appears to be a good strategy to reduce future taxable income by 10's of thousands. Other than filing another simple tax return, it seems like a no brainer.

Seems fine to me. While we're on the subject of no brainers, why in the world do you have a bond fund in a 12 year old's account?

Phil
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While we're on the subject of no brainers, why in the world do you have a bond fund in a 12 year old's account?

We're targeting the money for college expenses. I don't want to be forced to sell shares of a stock fund during a down turn.

-murray
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This appears to be a good strategy to reduce future taxable income by 10's of thousands.

Slow down, there. It's a good strategy to reduce future taxable income by $1900 this year. And another $1900 next year. (In practice, it's a bit less, as you'll have some interest and dividend income already.)

Remember that if her taxable income exceeds $1900 - even if some or all of that taxable income comes from long term capital gains and qualified dividends - the amount over $1900 gets taxed at your rate.

With a 12 year old, that will get you close to $20k in total cap gains over the next 10 years. Likely a bit more as the $1900 will get adjusted for inflation each year. So I guess that is two 10s of thousands. But even with inflation, you're not going to get to $30k for an accumulated total in the next decade.

--Peter
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Yeah, 10's may have been an exaggeration, but, as you pointed out, not by much, particularly if you start with a younger child.

-murray
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