Because of changes to the "kiddie" tax, the name of the rules governing the tax rates, applied to younger investors' income, probably should be changed. The age at which a child's usually lower rates kick in now is much higher, meaning the tax bills on such accounts is also higher.

In this tax tip: • Upping the age and the ante   • Two-tiered structure remains   • Choose whether child or parent files   • Child's income could cost tax breaks

The kiddie tax was created in 1986 to keep parents from sheltering income by putting accounts in the names of their lower-taxed kids. In its original form, a portion of investment earnings held by a child were tax-free. Watch "Children as tax deductions"

Another portion of earnings were taxed at the youngster's tax rate.

Any amounts over that second earnings threshold were taxed at the parent's highest marginal tax rate, which could be as high as 35 percent.

Relief arrived once the child turned 14, and the excess earnings were again taxed at the child's lower rate.

Upping the age and the ante
On May 17, 2006, however, the kiddie tax effectively grew up. On that day, the Tax Increase Prevention and Reconciliation Act took effect with a provision to keep the parents' tax rates in effect until the youngster turns 18.

For 2007 taxes, a young accountholder has to be four years older than the original kiddie tax age limit to take advantage of his or her lower tax bracket. And by the time the young person celebrates his or her 18th birthday, the accountholder is usually out of high school and possibly earning enough at a part-time or full-time job to no longer be in the lowest tax bracket.

But the readjusting of the age limit doesn't end there. For the second time in two years, this time thanks to the Small Business and Work Opportunity Tax Act of 2007, the kiddie-tax age limit was increased. For tax year 2008 and beyond, the young investor must be 19 to take advantage of his or her own, lower tax rates. The kiddie tax change also applies to investments of young people who are between ages 19 and 23 but who are full-time students.

Two-tiered structure remains
The age changed, but the basic dual-tax structure for children's investment accounts remained the same.

Children can still receive a portion of unearned income tax-free. For 2007 returns, the limit is $850, meaning that a child doesn't have to pay taxes on any interest, dividends or capital gains up to this amount.

The child does have to pay taxes on the next $850, but at his or her lower tax rate.

Once those 2007 earnings exceed $1,700, however, the preferential treatment ends. The earnings on those excess earnings are taxed at the parent's top marginal tax rate, rather than at the usual 15 percent capital gains rate.

For 2008 tax-planning purposes, a child's allowable investment income amount goes up to $1,800, with the first $900 in earnings exempt but the next $900 taxed at the child's rate.

Choosing whether child or parent files
To figure a child's tax in this case, you'll have to fill out Form 8615 and attach it to the youngster's federal income-tax return. If you and your spouse file jointly, the IRS wants the name and Social Security number of the parent who is listed first on the return so that it can ensure your child's tax is figured at the rate applicable to your joint income.

If you are married, but file separately, the name and tax ID number of the parent with the higher taxable income must be entered on Form 8615. It gets more complicated for parents who are separated, unmarried, treated as unmarried for tax-filing purposes or remarried. Check the Form 8615 instructions for details if one of these situations applies to your family.

Some parents save their child from tax-filing duties by reporting the youngster's investment income on the adults' return. This is an option if a child's earnings are only from interest and dividends, including capital gain distributions, and are less than $8,500. In these cases, the child's investment income is detailed on Form 8814, Parents' Election to Report Child's Interest and Dividends, and included with the parents' tax return. This way, the child doesn't have to file a return or Form 8615.

Child's income could cost parents tax breaks
Keep in mind, however, that when a parent adds a child's income to the adult's return, that extra money could mean the loss (or at least a reduced benefit) of some tax deductions and credits that are phased out as income grows.

You should run the numbers on Form 8615 and Form 8814 to guarantee that you, and your child, pay the least possible tax on the youngster's investment earnings. If you have more than one child with unearned income, you must repeat this process for each child.

And remember, these tax rules apply only to investment income received by children who are younger than 18 at the end of the tax year. For kiddie-tax age purposes, the IRS considers a child born Jan. 1, 1990, to be 18 years old at the end of 2007. That prevents the youngster's investment income from being taxed at his or her parents' higher rate. Wages and other earned income received by a child of any age are taxed at the child's normal rate.

More details on filing requirements for children can be found in IRS Publication 929, Tax Rules for Children and Dependents.

Freelance writer Kay Bell writes Bankrate's tax stories from her Austin, Texas, home. She also writes two tax blogs, Bankrate's Eye on the IRS, and Don't Mess With Taxes.