Posted by: Jorge Guerrero, CPA
Setting up an investment account for your children when they are very young is a great way to start saving for them, but there may be unexpected tax consequences to consider. The Kiddie Tax applies to all children up to age 18 and students 19 to 23 who do not provide more than 50% of their own support. Under Kiddie Tax rules, a child’s investment income, such as dividends, interest, and capital gains in excess of $2,000 is taxed at the parents’ highest marginal rate. The tax is calculated on the child’s tax return by completing Form 8615 – Tax for Certain Children Who Have Unearned Income.
The child’s investment income can be reported on the parent’s return if certain requirements are met. However, there are disadvantages that require careful consideration. This method may push the parents’ into a higher income bracket as well as affect eligibility of certain tax credits. Also, the parents’ 3.8% Net Investment Income Tax may increase. On the other hand, reporting the dependent child’s investment income on the parents’ return can have several advantages. This option is available when the child’s only income consists of interest, dividends, and capital gain distributions. It eliminates the need to file a return for the child. Also, the additional investment income on the parents’ return may allow the parents to deduct larger amounts for charitable contributions and investment interest expense.
According to IRS regulations, a dependent child may earn $1,000 of investment income tax free if this is their only income. The next $1,000 of investment income is taxed at the child’s rate and the remaining amount is taxed at the parents’ highest tax rate.
There are other factors to consider. Please talk to one of our tax professionals to determine whether the Kiddie Tax applies to you.