Shifting Income

Shifting income is one of the three primary tax planning techniques.  The other two are postponing the tax and changing the nature of the tax.  Shifting income moves income to a person in a lower tax bracket and has them pay the tax, assumably at a lower tax rate.  Thus, taxes are reduced.

Only passive or unearned income can be shifted.  The common technique used to shift income is to place an income producing asset (rents, interest, etc.) in the ownership of the child or parent that will ultimately receive the income and pay the tax.  You can shift income to anyone, but it is almost always a child, parent, grandparent or other family member who you want to help economically.

The rich have used income shifting to save big on taxes in the past decades.  Rich Daddy would place a huge amount of stock in the child’s name or in the child’s trust, and the child would get the dividends.  The child would then pay the tax on the dividends and get the wealth.  The wealth was then the child’s.  It would be out of Daddy’s estate when Daddy died, thus not subject to estate taxes.

Daddy is required by law to give the child food, shelter, clothing, and a primary education.  These are known as support obligations.  The money shifted to the child cannot be used for those purposes, otherwise it will be taxed back to Daddy.  BUT, any other expenses the child wants to make can be made out of the wealth transferred to the child.  Daddy is not obligated to give the child piano lessons, a car, or many other things.  Basically, by shifting income to the child, all of the non-support obligation items can be purchased with a dollar that wasn’t taxed as much or a dollar that wasn’t taxed at all.

In order to clamp down on excesses of shifting income, the IRS implemented what is called the Kiddie Tax.  The tax law says that any unearned income (passive income) obtained by a child (basically under 23) is subject to the tax.  It says that the tax will be calculated as if Daddy had earned the passive income, and then the child will pay that tax.  This is any passive income, even income the kid gets because he worked hard, earned money, and invested his own money.  The passive income received by the child stacks on top of Daddy’s income.  If that income is above the threshold where the child has to pay taxes on it (currently $2100), that could raise Daddy’s adjusted gross income and throw him into a higher tax bracket.

The Kiddie Tax has substantially eliminated the possibility of shifting income down to kids.  You can still do a couple thousand dollars or so each year for each child to pay for things that are not support obligations, but the days of tens of thousands of dollars shifted to the kids are over.

Headline technique for shifting taxes: Note that parents are not Kiddies – no Kiddie Tax. For those supporting a parent, shifting is a great technique.  You have no support obligation to your parents.  Thus, the shifted wealth can be used by the parent for any reason.  The parent is also not subject to what is known as the Kiddie Tax. If you are supporting a parent or grandparent, getting the money to them through shifting income means there could ultimately be more money available to them. This is because less tax is being paid when you use their lower tax bracket instead of your own.  Just be careful that the increased income doesn’t affect their Social Security or other benefits.

So, in some circumstances, shifting income can still be a valuable tax planning tool.