If you have a child under age 18 who receives investment income, you should be aware this unearned income may be subject to “Kiddie Tax.” When you have a child receiving unearned income, it is important to plan properly to minimize you and your child’s tax liability, and maximize your deductions.
What is the “Kiddie Tax?”
Kiddie Tax is actually not a tax at all. Instead, it is a limitation the IRS has put into place allowing a child under age 18 to have unearned income taxed at the child’s lower tax rate. Unearned investment income in your child’s name is potentially subject to “Kiddie Tax.” Investment income includes interest, dividends and capital gains.
The first $1,000 in unearned income a child under age 18 receives is not subject to tax. Income of more than $1,000 and up to $2,000 is allowed to be taxed at the child’s tax rate. However, when the child receives unearned income of more than $2,000, the amount over $2,000 must be taxed at the parent’s rate. As amended by the Small Business Work Opportunity Act of 2007, the age limitation increases to dependents under 19 and dependent full-time students under 24, if the child’s earned income does not exceed half of the child’s own support for the year.
How Do I Report My Child’s Unearned Income?
If your child makes more than $2,000 in unearned income, there are two ways to report this income.
- The first option is to prepare a return for your child. The kiddie tax would be computed using Form 8615, Tax for Certain Children Who Have Investment Income of More Than $2,000. If this option is chosen, the child’s unearned income over $2,000 will be calculated at the parent’s tax rate. If the child’s parents file separately, the parent’s highest tax bracket will be used.
- The second option is for you to report your child’s income on your tax return using Form 8814, Parent’s Election to Report Child’s Interest and Dividends. The first $2,000 is taxed at the child’s rate, but is not included in the parent’s taxable income. The amount over $2,000 is then taxed at the parent’s rate.
How Do I Decide Which to File?
When determining how to report your child’s unearned income, you should consider both possibilities to see the total tax effect for each. You should also consider the effect each situation would have on your tax breaks to maximize your tax credits and deductions.
If you report your child’s unearned income on your tax return, you will omit the hassle of filing a separate return for the child. However, the additional income reported on your return could accelerate the phase-out of itemized deductions because of Adjusted Gross Income (AGI) limitations. With AGI limitations, additional income could also phase out your ability to deduct your IRA contributions. Finally, this additional income could reduce the amount of credits available to you. The child’s income can be included on your tax return only if the child’s unearned income is in the form of interest or dividends. If your child has any capital gains or losses, the child would be required to file a separate tax return.
Reporting your child’s unearned income on his own tax return would not affect your AGI. Therefore, your child’s unearned income would not affect your eligibility for certain credits and deductions. For more information regarding how to best plan for the “Kiddie Tax” or any other tax-related issues, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.