Section 529 Plans - How to Avoid the Kiddie Tax
A great way to avoid the Kiddie tax when gifting money to a child is through the use of a Section 529 plan. It will also turn taxable income into tax-free income while allowing you to maintain control of the funds until the child begins post - secondary education.
With a 529 plan a parent or a grandparent can make annual gifts to the plan for the child. The earnings are deferred, and if the funds are used for qualified educational purposes the income is tax-free.
A donor to a 529 plan can elect to treat contributions made in a single year as ratably made over five years. This means that a taxpayer could put $65,000 into a plan and treat it as gifts of $13,000 per year for the next five years. Two things must be done to treat the contributions in this manner:
- The donor must file a gift tax return ot report the election. If the donor dies during the five year period, the ratable balance is included in the donor's estate, and
- If the donor makes additional gifts in subsequent years, the postponed amount could be subject to gift tax.