Figuring Out the "Kiddie Tax" Is No Child's Play

The "Kiddie Tax" was imposed in 1986 to prevent parents from concealing investment income by putting accounts in their children's names. Before this, a significant portion of investment earnings held by a minor child, was tax-free. There has since been a great deal of tinkering in what tax rates apply to children and students up to 23-years-old.

Rules to Save By

The "Kiddie Tax" only applies to investment earnings classified as "unearned income." Wages and other earned income received by a child under 18 are taxed at the child's normal rate.

Children's investment income, up to $1,000, remains tax-free. The next $1,000 of income is taxable, but at a reduced tax rate. Once a child's annual earnings exceed $2,000, there are specific rules as to how the income should be taxed.

If a child's interest, dividends and other "unearned income" exceeds $2,100, part of that income could be assessed at the parent's tax rate instead of the child's tax rate. Refer to IRS Form 8615 for specific instructions.

Filing under 8615 could subject this income to the Net Investment Income Tax (NIIT), a 3.8-percent tax on any amount that exceeds $2,100 (if needed, use Form 8960 to calculate this tax). If filing Form 8615, the IRS outlines taxable tiers according to the following situations:

  • The child was under age 18 at the end of the tax year.
  • 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 half of the child's own support for the year. If the child is a full-time student and received a scholarship, it is excluded.
  • The child was a full-time student between 19 and 23 years-old at the end of the tax year, and the child's earned income didn't exceed half of the child's own support for that year excluding scholarship(s).
  • If a child's parents are married but filing separately, Form 8615 must be attached to the return filed by the parent with the higher taxable income must be entered on. Calculations get more complex for separated, unmarried, "unmarried for tax-filing purposes," or remarried parents.

If the child did not generate any earned income, and his or her only income was generated by interest and dividends not exceeding $10,500, that income can be included on the parent's return with a Form 8814 in lieu of an 8615. If filing an 8814, the IRS outlines taxable tiers according to the following situations:

  • The child was under age 19, or a full-time student under age 24, at the end of the tax year.
  • The child's interest and dividend income did not exceed $10,500.
  • The child's only income came from interest, dividends, and capital gain distributions.
  • Form 8814 must be attached to the parent's 1040.

For additional requirements and information on which of forms/method for filing may be based for your specific tax-filing situation, please refer to the IRS Publication 929.

 

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