The “kiddie” tax has been part of the Internal Revenue Code (IRC) since 1986. In recent years Congress has increased the number of individuals subject to the kiddie tax rules in order to balance several tax decreases.
The kiddie tax rules are applied to individuals who are claimed as dependents — usually children.
But the kiddie tax rules do not apply if:
• a dependent child is not required to file a tax return; that is, if the child has less than a $950 income threshold for unearned income during 2009. Note that unearned income consists of interest, dividends and capital gains; or
neither of the child’s parents is alive at the end of the tax year; or
the child’s earned income – salary, wages or self-employment income – exceeds half of his or her support; or
the child is married and files a joint return.
The kiddie tax rules apply for tax year 2009 if:
at the end of 2009, the child is either: (a) under age 18, or (b) age 18 (or a full-time student age 19-23) and has earned income less than or equal to half of the child’s support;
the child has more than $1,900 of investment income for the year;
either parent was alive on Dec. 31, 2009; or
the child does not file a joint tax return for tax year 2009.
A child’s investment income is defined as follows:
Total Income – Earned Income = Investment Income
For 2009, a child’s investment income is first reduced by a $950 standard deduction. The next $950 is taxed at the child’s tax rate and the remainder is taxed at the parents’ tax rate.
The following table summarizes the tax treatment of a dependent child’s income for the year 2009:
There are two ways that a child can file a tax return in order to report potentially taxable income:
• Child files a separate tax return. In that case, IRS Form 8615, Tax for Certain Children who have Investment Income of More Than $1,900, must be completed and attached to the child’s Form 1040. If there is more than one child in a family subject to the kiddie tax, then the investment income of all such children is combined with the income of the parents to determine the tax liability.
If the child cannot sign the tax return, then either parent may sign the child’s name in the appropriate space. The notation “by, (parent’s signature), parent for minor child.”
• If certain requirements are met, then parents of a child who is subject to the kiddie tax may elect to report the child’s income on the parents’ tax return. Form 8814, Parents’ Election to Report Child’s Interest and Dividends, would have to be completed and included with the parents’ tax return. This option is available only if all of the following conditions are met: (1) the child’s only income is from interest, dividend and /or capital gain distributions; (2) the child’s total income for the year is less than $9,500; (3) no overpayments are applied to the child’s current year return; and (4) no estimated or withholding tax has been paid in the child’s name.
What are the advantages of reporting a child’s income on the parent’s tax return?
The advantages include:
no need to file a separate tax return for the child;
the first $1,900 of the child’s investment income is taxed on form 8814 and is not included in the parents’ taxable income; and
in states that base the parents state taxable income on federal taxable income, lower state tax liability could occur.
What are the disadvantages of reporting the child’s income on the parents’ tax return?
The disadvantages include:
higher adjusted gross income (AGI) for the parents, resulting in the possible loss of tax credits and deductions. Higher AGI could also result in a larger state tax liability for parents who live in states in which the state tax liability is based on the federal AGI; and
greater tax on the child’s income. When using form 8814, the child’s first $950 of income is taxed at 10 percent. If this income consists of capital gain distributions or qualified dividends, the applicable tax rate on a separate return for the child may be zero percent. Reporting a child’s income on the parent’s tax return and using Form 8814 to compute the child’s tax may result in as much as $95 (10% of $9,500) in additional taxes.
Finally, the Small Business and Work Opportunity Act of 2007 made significant changes to the kiddie tax by expanding the tax to additional individuals when all of the following conditions apply:
Children age 18 and younger; children age 23 and younger who are full-time students (until this law change, the kiddie tax rules applied only to children age 17 and younger);
The child’s earned income does not exceed half of his or her support for the tax year. Scholarships are not included when determining whether a child is providing at least half of his or her support.
The child has at least one living parent at the close of the tax year; and
The child does not file a joint return for the year.
Parents also need to be aware that some children may be subject to the Alternative Minimum Tax (AMT). The AMT exemption for a child whose investment income is taxed at the parent’s tax rate is $6,700 for 2009. IRS Form 6251 (used to compute the AMT) should be prepared in the event a child’s investment is greater than $6,700 and therefore subject to the AMT.
The following was issued by the IRS in March 2011.
What Parents Should Know about Their Child’s Investment Income
Parents need to be aware of the tax rules that affect their children’s investment income. Here are four facts from the IRS that will help parents determine whether their child’s investment income will be taxed at the parents’ rate or the child’s rate:
1. Investment Income Children with investment income may have part or all of this income taxed at their parents’ tax rate rather than at the child’s rate. Investment income includes interest, dividends, capital gains and other unearned income.
2. Age Requirement The child’s tax must be figured using the parents’ rates if the child has investment income of more than $1,900 and meets one of three age requirements for 2010:
3. Form 8615 To figure the child’s tax using the parents’ rate for the child’s return, fill out Form 8615, Tax for Certain Children Who Have Investment Income of More Than $1,900, and attach it to the child’s federal income tax return.
4. Form 8814 When certain conditions are met, 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. In this situation, the parent would file Form 8814, Parents’ Election To Report Child’s Interest and Dividends.
More information can be found in IRS Publication 929, Tax Rules for Children and Dependents. This publication and Forms 8615 and 8814 are available at http://www.irs.gov or by calling 800-TAX-FORM (800-829-3676).