Planning for the Kiddie Tax

The Kiddie Tax requires that unearned income generated by children under age 19 (or 24 for full-time students) is taxed at their parents’ rate rather than their own. The Kiddie Tax applies only to unearned income such as stock dividends, mutual fund dividends, and interest payments.

The Kiddie Tax was put in place to prevent high-income households from channeling income through their children to decrease their overall taxes. Prior to 2006, the Kiddie Tax was not applicable after a child turned 14. Now that the parameters of this tax have expanded past the age at which many students graduate college, a custodial account (set up in the interest of saving and paying for the child’s college education) may also fall prey to this tax.

The Kiddie Tax comes into play if the child’s income (from the interest and dividends on investments) exceeds $1,900. If this happens, a portion of their income will be taxed at their parent’s tax rate. This does not include any money that may have been earned by the child through self-employment or a summer job.

If your child has investment income from interest and dividends, it must be reported using IRS Form 8615 (Tax for Certain Children Who Have Investment Income of More Than $1,900). This form should be filed and attached to the child’s income tax return (Form 1040, Form 1040A, or Form 1040NR). Form 8615 is not meant to accompany the parent’s tax return ? a mistake that is commonly made.

Age Limit Changes

The age limits for the Kiddie Tax have been modified over the past several years. Before 2006, the Kiddie Tax did not apply to children 14 years or older. In 2006 and 2007, the tax was expanded to include all children under the age of 18. More recently, however, the Kiddie Tax was adjusted again ? now it applies to children under the age of 19 (if they are dependent) or under the age of 24 (if they are full-time students).

Is the Kiddie Tax Necessary?

There are a large number of people who feel that the Kiddie Tax should be phased out completely. But the reason it exists is relatively simple ? in the past, it was popular for rich parents to give their children stock. In turn, the children could sell the stock and be subject to less capital gains tax (than their parents). The Kiddie Tax was implemented to prevent wealthy parents from shifting their stock holdings to their children in order to reduce their taxes.

Offset the Kiddie Tax with Tax Credits

Are you looking for a way to lessen the impact of the Kiddie Tax? There are various child tax credits available to help families reduce their tax liability, including the following:

• The Child Tax Credit
• The Additional Child Tax Credit
• The Adoption Tax Credit
• The Child and Dependent Care Expenses Tax Credit

The federal government also provides education tax credits (which can ease the cost of your child’s tuition and related expenses) and the Earned Income Tax Credit (which is designed for low-income families with qualifying children).

Understandably, most parents focus on their own tax returns and how they can save money, since they are the main income-earners. Taking advantage of child tax credits can be beneficial for your personal tax liability, but remember that the Kiddie Tax actually affects the child’s tax situation.

As a parent, it is important to be aware of the Kiddie Tax and its possible implications. You may want to think twice before investing money on behalf of your child. If possible, search for investment options that will allow your child to avoid triggering the Kiddie Tax. At the very least, make sure to help your child fill-out and submit Form 8615 if they make over $1,900 in unearned income.

---