As part of the new tax law passed earlier this year, Congress extended the reach of the so-called “kiddie tax.” Despite its innocent-sounding nickname, the tax might start to affect families with children well into their twenties.

Background: Normally, income is taxed at the tax rate of the person who receives it. However, unearned income received by a child may be taxable at the top marginal tax rate of the child’s parents to the extent that it exceeds an annual threshold. In other words, instead of being taxed at the child’s tax rate (usually 10% or 15%), the effective rate on the income may be as high as 35%.

The annual threshold is adjusted for inflation. For 2007, the limit is $1,700 (unchanged from 2006). The first $850 is tax-free; the next $850 is taxed at the child’s tax rate.

Reminder: The tax only applies to unearned income (e.g., capital gains, dividends and interest). Any other income your child earns is exempt from the kiddie tax.

Prior to 2006, the kiddie tax applied only to children under the age of 14. Then a major tax law passed last year raised the age limit to 18. Now the new tax law—the Small Business Work Opportunity Tax Act of 2007—extends the kiddie tax to certain older children.

New Tax Rule: Beginning in 2008, the age limit is increased to age 19 or age 24 for full-time students. These higher age limits apply if the child does not have earned income equal to half of his or her annual support. In other words, you can’t avoid the kiddie tax just because you are no longer claiming the child as your dependent.

Keeping this change in mind, here are several possible ways to reduce the impact of the kiddie tax.

• Monitor Your Child’s Investment Income.
  If you are careful to stay below the $1,700 fault line, you won’t have any kiddie tax problems at tax return time. For instance, in 2008 you might invest in CDs that won’t mature until 2009 on behalf of the child.



• Emphasize Tax-Deferred Investments.
  Instead of investments that produce current income, shift more of your child’s portfolio into long-range vehicles such as growth stock. Similarly, if you buy U.S. Savings Bonds in the child’s name, he or she generally doesn’t have to pay any current tax.



• Switch Some Investment Dollars Into Municipal Bonds.
  Usually, there are no federal tax consequences for investments in municipal bonds or municipal bond funds. Reason: The income received is exempt from federal income tax.



• Hire Your Child.
  Because the wages are earned income, the kiddie tax doesn’t apply. Assuming that the child is paid a reasonable amount for the services actually performed, the business can deduct his or her salary.

• Standard Features
  Although the exact components will vary, certain features are often offered as part of the standard package. For instance, the system may include an auto-attendant that answers the phone and directs callers to a specific person or department. Note: Even if your company experiences a high volume of calls, you may prefer having a “live” person answer each call.
  
  Conferencing features may also be included in a standard offering. Another common feature is music-on-hold. In addition, the system should enable callers to find people and services at the touch of a button.
  
  The telephones themselves may provide a display of the name and extension of an internal caller, the duration of call and, in some cases, caller ID. The ability to put a caller on speaker phone is also standard in most systems.
  
  Voicemail could be included in a standard package. If it is not, it might be possible to use an existing voicemail setup with a new telephone system you are buying. Consult with the vendor.

• Advanced Features
  For companies that have more sophisticated needs, modern systems offer many high-tech features. For instance:
  • With automatic call forwarding, you can redirect incoming calls to employees at home or other remote locations.
  • Computer telephony integration (CTI) covers a wide range of applications connecting computers to the phone system.
    Example: You might use one-click dialing for an outbound call center. This way, employees can use contact management applications to place calls without entering the number manually.
  • Other CTI applications coordinate incoming calls with caller ID. For instance, a customer’s information may be displayed automatically when an employee picks up.
  • Automatic call distribution manages incoming calls to maximize efficiency. It can also track calls to help improve responsiveness.

1. Direct Compensation Amounts
   • Basic Salary: This speaks for itself. Naturally, offering a higher wage can provide a competitive advantage in your industry.
   • Incentive Pay: This includes bonuses that are paid out when certain objectives are met. Incentive pay may inspire employees to exceed previous performance levels.
   • Stock Options This is a way to reward top employees with a small piece of the business. Certain qualified stock options (called incentive stock options) have tax advantages.
   • Bonuses: Additional cash compensation may be paid to employees (typically around the end of the year). An unexpected bonus can show employees that you value their services.

2. Indirect Compensation Amounts
   
   In some cases, indirect compensation is required by law. For instance, employees may be entitled to receive Social Security, unemployment or disability payments upon the happening of an event. At other times, an employer can step forward and deliver a meaningful message.
   
   This is just a partial list of the possibilities:
   • Flexible working schedules
   • Eldercare benefits
   • 401(k) or other retirement plan
   • Moving expenses
   • Insurance (health, dental, vision)
   • Paid leave (sick days/holidays/personal days, etc.)
   • Tickets to events (ballgames, theatre, concerts, etc.)
   • Company party or picnic
   • Cell phones/pagers and other electronic devices
   • Child care services