The Small Business and Work Opportunity Tax Act of 2007 was signed into law on May 25, 2007. Included int eh Act are various small business tax incentives and a few revenue raisers such as new and enhanced penalties and broadening of the kiddie tax.

Previously, a child subject to the kiddie tax pays tax at his or her parents’ highest marginal rate on the child’s unearned income over $1,700 if that tax is higher than the tax the child would otherwise pay on it. In the alternative, parents could elect to include the income on their own return the child’s gross income in excess of $1,700. A child was subject tot the kiddie tax if he or she has not attained age 18 before the close of the tax year; either parent of the child is alive at the end of the tax year; and the child does not file a joint return for the tax year.

For tax years beginning after May 25, 2007, the kiddie tax rules apply to children age 18, and children over age 18 but under age 24 who are full-time students – their earned income doesn’t exceed on-half of the amount of their support.

This expansion of the kiddie tax rules attempt to curtail a strategy some parents were advised to use to take advantage of a beneficial feature of the long-term capital gains rates. The top tax rate on “adjusted net capital gain” in 2007 is 15%. But to the extent a taxpayer’s adjusted net capital gain would otherwise be tax in the two lowest tax brackets (10% and 15%) it’s taxed at 5% for 1007 and 0% for 2008 through 2010. Same families sought to benefit from these rates by gifting appreciated stock, mutual-funds shares, and other securities to their low-income, young-adult children, who could then sell the securities tax-free in 2008, 2009, and 2010. The new law changes will eliminate the opportunity to do this in many cases. However, if the earned income of a child over age 18, or age 19-23 if a full time student, exceeds one-half his or her support, the kiddie tax rules won’t apply and he or she will be able to take advantage of the 0% capital gains rate next year and his or her own bracket on other types of unearned income.

Earned income is always taxed at the child’s tax rates. Thus, one way of providing a child with income without triggering increased tax liability under the kiddie tax rules is to employe the child (at reasonable compensation) in, for example, a trade or business owned by the parent. Computer-literate children, for example, could help with a variety of tasks. As a result, the child’s earnings won’t be subject to the kiddie tax and will generate a deduction for the family business. As an added bonus, this could help to avoid the kiddie tax on unearned income of a child age 18 or age 19-23 if a full0time student.

For purposes of the kiddie tax, support is defined the same as it is for the dependency deduction requirement that a qualifying child not provide more than one-half of his or her own support for the tax year, but any scholarships received by a student for study at an educational organization are excluded in determining the total support paid for the student for the tax year.

You should discuss the options for dealing with your children’s tax liability with your tax professional. Gifting strategies and other estate planning tools can still be used to reduce your tax burden.