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STEVE ROSEN: Why penalize young investors?

Get ready for the new "kiddie tax."

But, after what Congress approved before the Memorial Day weekend, better to call it the "college student tax."

Millions of families won't be chuckling over that suggestion, however, especially if they have to grapple with revised tax rules that were signed by President Bush in late May.

The Small Business and Work Opportunity Tax Act of 2007 covers the waterfront - funding in Iraq, a minimum-wage increase and tax incentives for Hurricane Katrina victims. Much deeper in the legislative summaries is information about the expansion of the so-called kiddie tax.

Hoping to raise an estimated $1.4 billion in the next decade, Congress boosted the age of those subject to the kiddie tax by one year - from under age 18 to under age 19.

But here's possibly the big hit: Full-time college students under age 24 are snared. So, if you thought your 22-year-old college student had outgrown this tax, guess what: He or she could be subject to these provisions again.

This marks the second consecutive year that the tax has been expanded. Before the law was changed last year to reach children 17 years old or younger, the kiddie tax applied only to children younger than 14.

The tax was enacted in the late 1980s and was intended to keep parents from ducking taxes by shifting income to their children's control through the gifting of cash and other assets, mainly into custodial accounts. This rule applies to investment income from interest and dividends, for example, rather than earned income from a paycheck, which is taxed at the child's tax rate.

Under the new rules - and Congress didn't tinker with these limits - children can make up to $850 in investment income without having to pay any taxes. Income between $850 and $1,700 is taxed at the child's lower rate. But if the child is the principal owner of these investments, any income above $1,700 is taxed not at a child's rate, but at parents' tax rates. This expanded provision doesn't apply to children whose income from work is more than half the amount of their financial support.

If there's good news, it's that the changes don't become effective until Jan. 1, 2008. That gives parents and children seven months to adjust their tax and investing plans.

I don't object to children paying their share of taxes - certainly many teens already are intimately familiar with Form 1040. But why penalize them, in my opinion, by taxing them at the high end on investment gains rather than at their own lower rate?

"This seems to discourage saving," said Sophie Beckmann, personal finance strategist for A.G. Edwards & Sons in St. Louis.

This regulation also makes no sense when you consider that a lot of the investment income in the hands of children has probably been bankrolled for college education.

Think about it. At a time when students need this money the most to cover out-of-control college costs, they are being taxed at the heaviest rate. Perhaps what Congress had in mind was to create a larger class of student borrowers.

I don't know how many youngsters actually generate enough annual investment earnings to trigger this tax. No doubt, many are trust fund children from very wealthy families, while others have been fortunate enough to have been given cash or investment gifts from parents and grandparents for education. But, I also suspect many are teenage taxpayers who have plowed money into custodial investment accounts for college from several years' worth of umpiring, lawn mowing, baby-sitting and other summer jobs.

What can parents do to minimize the impact of the new regulations?

Beckmann said state-sponsored 529 college savings plans should become more attractive because investments in those plans are not subject to the kiddie tax. If your child has investments in a custodial account, for example, cash out and roll the proceeds into a 529 plan, she said, though there may be capital gains taxes.

Another tip: Consider investments that do not increase a child's taxable income, such as growth stocks and mutual funds, tax-exempt municipal bonds and even tax-deferred U.S. savings bonds, said Julie Welch, an accountant with Meara, King & Co. in Kansas City.

As an alternative to a cash gift, parents who own small businesses might consider putting their older children on the payroll. That's because the kiddie tax doesn't apply to earned income, said Mark Cook, tax director at Howe & Co. in Kansas City. But be careful to check on tax implications of this strategy.

Indeed, when it comes to the kiddie, er ... college, student tax, there are many potential minefields.

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