Bush Bill Raises Taxes on One Group -- Kids

May 22, 2006 — -- President Bush signed into law last week a bill that creates nearly $70 billion worth of tax cuts for American taxpayers, but it could affect the future education of many of America's teens.

While seeking the presidential nomination in 1999, Bush pledged never to increase taxes. But the recent measure does include an increase in taxes for teens 14 to 17 years old who have college savings funds.

Many students need not worry. The bill will not affect the popular 529 college savings plans, which cover college expenses and are tax free. The changes in the bill will affect teenagers with custodial accounts. Those are taxed according to the the "kiddie tax."

The kiddie tax was introduced in 1986 to curb the benefit of the progressive tax rate. Before then, all children with savings funds submitted their own tax returns, but that meant that wealthy families could transfer funds to their children's name, gaining from the lower tax rate (as low as 5 percent compared with up to 35 percent for their parents).

The kiddie tax sought to correct that by considering all children under 14 as supported by their parents.

Under the old rules, children under the age of 14 with investment income under $850 would not be taxed. The next $850 would be taxed at the child's tax rate. Anything above $1,700 would fall under the kiddie tax, in which the child's income would be taxed at the parent's rate. But once the child turned 14 any income would be taxed at the child's usually lower interest rate.

So what changed?

The new law -- which takes effect retroactively on Jan. 1, 2006 -- raises the age of the kiddie tax from 14 to 18. By raising the age, children will continue to be taxed at the parents' rate for any investment income above $1,700 until they turn 18. The new rules could raise as much as $ 2.2 billion over the next 10 years.

In his speech just before he signed the bill, President Bush expounded on the "good day for American workers and families" and claimed the measure "reduced taxes for every American who pays income tax."