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.

Getting Rid of the Tax Shelter for the Wealthy?

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."

Despite such statements, Grover Norquist, president of Americans for Tax Reform, does not see the increase as a violation of the president's pledge, claiming it was put in at the last minute and his staff did not notice it until after the bill had been signed.

"We would like to abolish the kiddie tax permanently," Norquist said, arguing that it raises the cost of capital and prevents saving for college.

The measure was quick to draw the attention of Democrats in the House and Senate.

Sen. Minority Leader Harry Reid, D.-Nev., and eight other lawmakers released a statement Wednesday protesting the measure. "In rushing to push through a tax-cut plan to placate their increasingly restive base, Republicans stripped away tax deductions that would have helped students pay for college in order to pay for handouts to big business and multimillionaires."

However, some tax experts thought the kiddie tax was nothing more than a loophole that primarily benefited wealthier families anyway. Leonard Burman, co-director of the Tax Policy Institute, believes the age increase makes sense. "It seems appropriate, as children under 18 mostly depend on their parents," Burman said.

Bob McIntyre of Citizens for Tax Justice agreed, referring to the kiddie tax as "just a tax shelter" benefiting the wealthy, who are already getting a tax cut with this bill.

"On net, this [bill] represents a huge tax cut for wealthy families," Berman said. "This is actually a rare element of fiscal responsibility in what is otherwise a very irresponsible bill."