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This may look like a cute little title, except for the “tax” part! As a matter of fact, the full name of the topic we are referring to is “Tax Rules for Children Who Have Investment Income”.
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Investment income is considered unearned income, but is just as taxable as earned income, and has its own rules.
Types of unearned income which may be taxed under this rule include stocks, mutual funds, investment incomeand capital gains, taxable Social Security benefits, annuities, rents, royalties.
The Kiddie Tax was designed to discourage parents who were trying to reduce their taxes by shifting their investments over to their children. At one time, it only applied to children under age 14., hence its name.
Under the Kiddie Tax rule, certain unearned income of a child is taxed at the parent’s marginal rate, no matter whether the child can be claimed as a dependent on the parent’s return. The marginal tax rate is the amount of tax paid on an additional dollar of income. As your income increases, the marginal tax rate increases but only for that portion of your income within the higher bracket.
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The following two rules may affect the tax and reporting of the unearned income of certain children:
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- If the child’s interest, dividends, and other unearned income total more than $2,100, the amount over $2,100 is taxed at the parent’s marginal tax rate if that rate is higher than the child’s, and
- If the child’s interest and dividend income (including capital gain distributions) total less than $10,500, the child’s parent may be able to elect to include that income on the parent’s return rather than file a return for the child.
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| If the child files a return, Form 8615, Tax for Certain Children Who Have Unearned Income, is required to be attached to the tax return. |
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| In general, a child is required to file a tax return when: |
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- The child's unearned income was more than $2,100;
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- The child meets one of the following age requirements:
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The child was under age 18 at the end of the tax year, |
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The child was age 18 but less than 19 at the end of the tax year and the child's earned income didn't exceed one-half of the child's own support for the year (excluding scholarships if the child was a full-time student), or
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The child was a full-time student who was at least 19 and under age 24 at the end of the tax year and the child's earned income didn't exceed one-half of the child's own support for the year (excluding scholarships)
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- At least one of the child's parents was alive at the end of the tax year;
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- The child is required to file a tax return for the tax year, and
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- The child doesn't file a joint return for the tax year.
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| If your child is required to file a tax return, they may also be subject to the Net Investment Income Tax (NIIT) which is 3.8% tax on the lesser of net investment income or the excess of the child's modified adjusted gross income over a threshold amount set for the respective year. |
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| A parent may be able to avoid having to file a tax return for the child by including the child's income on the parent's tax return. To make this election, attach Form 8814, Parents' Election to Report Child's Interest and Dividends, to your Form 1040 or Form 1040NR when: |
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At the end of the tax year the child was under age 19 or under age 24, if a full-time student; |
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The child's interest and dividend income was less than $10,500 for the tax year; |
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The child had income only from interest and dividends, which includes Alaska Permanent Fund dividends and capital gain distributions;
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No estimated tax payments were made for the tax year, and no prior tax year's tax overpayment was applied to the current tax year estimated tax, under the child's name and social security number; |
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No federal income tax was withheld from the child's income under backup withholding;
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The child is required to file a return unless the parent makes this election; |
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The child doesn't file a joint return for the tax year;
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The parent is the parent qualified to make the election or files a joint return with the child's other parent.
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The IRS considers any taxable income a child earns as the child’s, but in the end, the parent is liable for filing the return and for any taxes owed on the taxable income.
Deductions may be claimed on the child’s tax return, even if the expenses may have been paid by the parent. |
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Keep in mind that, when you add your child's income to your return, the 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.
Therefore it is better to run the numbers on both 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. |
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| You should also pay attention to the IRS instructions on determining your child's age. The IRS tax year is slightly different than the calendar year when it comes to the kiddie tax. |
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| It is, of course, our recommendation that you consult a professional to make sure all options are considered and suitable tax-planning is in place to reduce the kiddie tax to the minimum allowable. |
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