Prior to 1986, parents were able to shift investments to their children so that interest and dividends were reported on the child’s tax return often resulting in the child paying little or no tax at all. This tax strategy was expunged by the birth of the kiddie tax. Children with unearned income such as interest or dividends above certain thresholds ($2,000 for 2013) are subjected to this tax. The excess investment income is taxed at the parent’s highest marginal rate not at the child’s marginal rate.
Kiddie tax rules apply to:
a. children under the age of 18 at the end of the year
b. children aged 18 with earned income (a job) does not exceed one-half of their support
c. children between the ages of 19-23 who are full-time students and whose earned income does not exceed one-half of their support.
How this tax works
When a child’s investment income exceeds $2,000 (for 2013), any unearned income above this amount is subject to the Kiddie Tax; your (the parent’s) highest marginal tax rate. This rate could be as high as 39.6%.
The kiddie tax may be paid in two ways:
1. Include your child’s investment income on your tax return using Form 8814
2. Your child files their own separate return using Form 8615.
Either way, the tax will be the same.
Things to Consider
• A child is a natural offspring, a legally adopted child and a stepchild.
• These tax rules are upheld regardless of whether the child is considered a dependent or not for tax purposes.
• Something to consider is if the increase to your own taxable income will prevent you from taking certain deductions and credits such as education etc.
• Your name and social security number will be on your child’s return if the Form 8615 is filed
• The kiddie tax rules do not apply if the child is married and files a joint return.
• An exception applies to distributions from some qualified disability trusts.
• If parents are divorced then the custodial parent’s return would be used even if that person is remarried.
• If parents are married but file separately or parents who are not married, use the parent’s return with the highest taxable income.
Your daughter has $500 wages and $2,035 in dividends. On Schedule A, she claims itemized deductions of $400 due to investment income after 2% AGI floor. With an additional $800 of itemized deductions her total deductions claimed is $1,200. Gross income less itemized deductions equals a taxable income of $1,335.
What is subject to tax at the parent’s rate?
Investment income $2,035
less (the greater of $2,000 or the sum of $1,000
plus directly related expenses of $400). $2,000
Subject to kiddie tax $35
Contact your William Vaughan Company consultant and discuss the kiddie tax and how you can minimize its impact.
By: Tammy Scheuermann, Accountant