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Child's Unearned Income Can Trigger 'Kiddie Tax'

By Marcia Richards Suelzer, MA, JD | June 29, 2012

If your son or daughter has more than $1,900 of investment (not earned) income, that income might be taxed at your tax rate, rather than at your child's tax rate, as a result of the "kiddie tax" rules.

The "kiddie tax" was enacted back in 1986 to prevent high-income parents from shifting income to lower-income children, thereby reducing the family's overall tax liability. Initially, the provision's nickname, "kiddie tax," seemed to fit: it applied only to children who were under age 14 at the end of a calendar year. But, law changes have expanded its reach to teenagers and young adults, making it an issue for more high-income families.

Example. Frank Burns transfers all of his shares of several biotechnology stocks to his 16-year-old son, Frank Jr. During the year, Frank Jr. receives $5,000 in dividends. Frank Jr. has no earned income. Without the kiddie tax, the $5,000 in unearned income would be taxed at Frank Jr.'s tax rate of 10 percent, rather than his father's 35 percent tax rate. However, as a result of the kiddie tax, the $5,000 is taxed at Frank Sr.'s tax rate.

Income and Age Requirements

The kiddie tax applies only to unearned income, such as interest, dividends and capital gains. Distributions from trusts are generally considered unearned income. It never applies to the child's earned income. The tax on the child's unearned income must be calculated using the parents' tax rate if the child meets any one of these three tests as of the end of the year:

  • The child was under age 18 at the end of the year,
  • the child was 18 and did not have earned income that was more than half of his or her support, or
  • the child was:
    • a full-time student;
    • over age 18 and under age 24; and
    • did not have earned income that was more than half of his or her support.

Electing to Claim the Income on Your Return

Whether your child reports the income on his or her return, or you report it on your return, it is going to be taxed at your tax rate. In recognition of this, the IRS allows the parent to elect to report the child's unearned income provided:

  • the child is under 19 (24 if a full-time student) as of December 31;
  • the child's only income is from interest or dividends; and
  • the child's gross income was $9,500 or less.

Assuming that you can do so, should you elect to report it on your return and avoid the aggravation of filing a return for your child? The answer depends upon your overall tax picture. Adding the child's income to your own will have an impact on any deductions or credits that have limitations based upon adjusted gross income, such as miscellaneous itemized deductions, casualty losses or education credits. If the child's income is substantial and you are close to those limitations, then you will want to calculate the impact both ways.

If the numbers work out, you make the election by filing Form 8814, Parents' Election To Report Child's Interest and Dividends, with your tax return. Otherwise, you would complete Form 8615, Tax for Certain Children Who Have Investment Income of More Than $1,900, and attach it to your child's federal income tax return.

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