When it comes to Idaho college planning, our lawmakers created traps for parents. This tax destroys the traditional IRA as an Idaho college funding source and does much the same to your child’s interest and dividends savings.
For example, consider the three questions and answers below:
Does the tax code penalize children who accumulate a college nest egg in Idaho and currently have $7,000 in dividends and interest that they use for college?
Yes, more than likely!
Does the tax code penalize children who withdraw $7,000 in funds from a traditional IRA and use that money for college in Idaho?
Yes, more than likely, but not as you would expect.
Does the tax code penalize children who withdraw $7,000 in funds from a Roth IRA and use that money for Idaho college?
No, not if the withdrawal is from contributions only.
The problem in questions 1 and 2 is the kiddie tax. It applies the parents’ highest tax rate to the under-age-24-student child’s unearned income when
- the child’s unearned income is more than $2,100, and
- the child’s earned income is not more than half of his or her support.
The kiddie tax applies regardless of whether your child as your dependent if the child’s earned an income, is not more than half of the child’s support.
Jane sells the stock for $90,000 that her grandmother gave her. At the time of sale, the stock has a basis of $10,000, and that produces an $80,000 capital gain. Jane uses the $90,000 for living expenses and college in Idaho. Her parents provided none of her support for the year. But because of the kiddie tax, Jane pays taxes on the $80,000 capital gain at her parents’ tax rate.
To avoid this tax, you must investigate and read all the fines lines when setting up a tax-friendly college saving plan in Idaho.