In an effort to raise money to pay for other federal programs, Congress changed the child investment earnings rules, popularly known as the kiddie tax, last May. The change, however, was made retroactive to all transactions since Jan. 1, 2006.
Previously, when an account was held in a child's name, any earnings exceeding an annual threshold amount ($1,700 in 2006) were taxed at the parents' highest marginal tax rate. But when the child turned 14, his or her usually lower tax rates applied. Now, however, the cutoff age is 18, meaning the higher adult tax rates apply for four additional years.
"Your highest marginal rate will be applied to the investment income of your children," says LeValley. "So if you're in the 25 (percent) or 30 percent marginal rate, that's what will apply to the investment income instead of the 15 percent capital gains rate."
In essence, families who had utilized this tax strategy now lose not only the lower capital gains rates that would normally have applied to most long-term investment transactions, but also the benefit of the child's lower rates for any short-term profits. The excess child's investment income is essentially taxed at his or her parents' much higher tax rates.
Compounding the problem is the date shifting of the law's effective date. "People who made a move this year -- rebalanced the portfolio because the youngster is closer to college or they sold assets held by the child to pay for tuition -- they are going to owe more," says LeValley.
8. Foreign income adjustments
U.S. workers with jobs abroad will likely find they're now paying a higher tax price for their globe-trotting careers because of changes to the foreign earned income exclusion rules.
Under IRS rules, workers must pay U.S. taxes on their earnings regardless of where they live to make the money. However, if they pay taxes to the country where they are working, American taxpayers are allowed to exclude part of their foreign-earned income from U.S. taxes.
A new tax law bumps the 2006 exclusion amount up a bit -- to $82,400 -- but it adds some other tax burdens. In the past, after an overseas worker subtracted the exclusion amount, the worker was able to figure U.S. taxes on the remaining income. Now, however, regardless of the final taxable dollar amount, it is taxed as if it were still in the bracket it would have been before the exclusion was allowed.
Basically, that means expatriate workers will lose the tax-reducing value of the lower brackets in our progressive tax system. For example, if you make $100,000 overseas, your tax bracket is based on that amount, not just on the $17,600 you have after subtracting the $82,400 exclusion from your overall $100,000 income. That means that instead of figuring taxes on the $17,600 by beginning at the 10 percent bracket, the foreign-based worker would calculate starting at the 28 percent bracket into which the pre-exclusion income amount fell.