If your child has been socking away those gift checks and trading stocks along with the E-Trade baby, you could have some reporting to do. Special rules apply to anyone who can be claimed as a dependent on another return. These rules apply regardless of whether you actually claim your child as a dependent; the key is if you could claim your child as a dependent.
Parent’s Election to Report Child’s Income
If your child has unearned income (taxable interest, dividends, capital gains) in excess of $1,000, there is a reporting requirement. The parents can elect to report this income on their own return if all the following conditions are met:
- The child’s only income for the tax year is from interest and dividends and the income was more than $1,000 and less than $10,000.
- No estimated tax payments were made in the child’s name and social security number
- The child is not subject to backup withholding
- The child must be under the age of 19 at the end of the tax year, or under age 24 if a full-time student.
The election is made using Form 8814, Parent’s Election to Report Child’s Interest and Dividends. The form takes you through a calculation where the first $1,000 is not taxed (this is the child’s standard deduction amount). The next $1,000 is taxed at 10%. The balance is then used in the calculation of the parent’s tax, and taxed at the parent’s rate. This is referred to as Kiddie Tax.
Kiddie tax laws are meant to tax wealthy families who transfer investments into their children’s names. Historically, families would pay a lower tax rate on the income from those investments, because they were paying at the child’s tax rate. Kiddie Tax was introduced to remedy this loophole. Now all children under the age of 19, or under the age of 24 if a full-time student, are taxed at their parent’s rate on unearned income.
Reporting on your Child’s Return
If your child’s unearned income hits the $1,000 or greater threshold, but includes items other than interest and dividends, or if your child has earned income (wages or non-employee compensation) in excess of $6,200, then the child must file their own tax return.
The child must include Form 8615, Tax for Certain Children Who Have Unearned Income, if their net unearned income is more than $2,000. Form 8615 calculates the Kiddie Tax due, taking into account the parent’s taxable income and the unearned income of any siblings.
Be careful not to use earned income in these Kiddie Tax calculations.
California conforms to Federal treatment for Kiddie Tax, using a similar calculation. Consult your tax advisor for more information.