TAX TIP No. 60
IRS rules for child's investment income
changes to the "kiddie"
tax, the name of the rules
governing the tax rates applied
to younger investors' incomes,
probably should be changed.
The age at which a child's
usually lower rates kick in
now is much higher, meaning
the tax bills on such accounts
is also higher.
|In this tax tip:
||Upping the age and the ante
||Two-tiered structure remains
||Choose whether child or parent files
||Child's income could cost tax breaks
The kiddie tax
was created in 1986 to keep
parents from sheltering income
by putting accounts in the
names of their lower-taxed
kids. In its original form,
a portion of investment earnings
held by a child were tax-free.
Another portion of earnings were taxed at the youngster's
Any amounts over that second earnings threshold
were taxed at the parent's highest marginal tax
rate, which could be as high as 35 percent.
once the child turned 14, and the excess earnings were again taxed at the child's
Upping the age and the ante
On May 17, 2006, however, the kiddie tax effectively
grew up. On that day, the Tax Increase Prevention and Reconciliation Act took
effect with a provision to keep the parents' tax rates in effect until the youngster
But the readjusting
of the age limit didn't end
there. Thanks to the Small
Business and Work Opportunity
Tax Act of 2007, the kiddie-tax
age limit was increased once
again. For tax year 2008 and
beyond, a young investor now
must be 19 to take advantage
of his or her own potentially
lower tax rates. Even after
the youth turns 19, the kiddie
tax still applies to his or
her investments if he or she
is between ages 19 and 23
and a full-time student.
All this kiddie tax tweaking means that by the time a young investment account holder can take advantage of his or her lower tax bracket, he or she will likely be out of high school and possibly earning enough at a part-time or full-time job to no longer be in the lowest tax bracket.
Two-tiered structure remains
The age changed, but the basic dual-tax structure
for children's investment accounts remained the same.
can still receive a portion of unearned income tax-free. For 2008 returns, the
limit is $900, meaning that a child doesn't have to pay taxes on any interest,
dividends or capital gains up to this amount.
The child does
have to pay taxes on the next $900, but at his or her lower tax rate.
those 2008 earnings exceed $1,800, however, the preferential treatment ends. The
earnings on those excess earnings are taxed at the parent's top marginal tax rate,
rather than at the usual 15 percent capital gains rate.
For 2009 tax-planning purposes, a child's allowable investment income amount goes up to $1,900, with the first $950 in earnings exempt but the next $950 taxed at the child's rate.
Choosing whether child or parent files
To figure a child's tax in this case,
you'll have to fill out Form
8615 and attach it to the youngster's federal income-tax return. If you and
your spouse file jointly, the IRS wants the name and Social Security number of
the parent who is listed first on the return so that it can ensure your child's
tax is figured at the rate applicable to your joint income.
you are married, but file separately, the name and tax ID number of the parent
with the higher taxable income must be entered on Form 8615. It gets more complicated
for parents who are separated, unmarried, treated as unmarried for tax-filing
purposes or remarried. Check the Form
8615 instructions for details if one of these situations applies to your family.
save their child from tax-filing
duties by reporting the youngster's
investment income on the adults'
return. This is an option
if a child's earnings are
only from interest and dividends,
including capital gain distributions,
and are less than $9,000.
In these cases, the child's
investment income is detailed
8814, "Parents' Election
to Report Child's Interest
and Dividends," and
included with the parents'
tax return. This way, the
child doesn't have to file
a return or Form 8615.
Child's income could cost parents tax breaks
Keep in mind, however, that
when a parent adds a child's income to the adult's return, that extra money could
mean the loss (or at least a reduced benefit) of some tax deductions and credits
that are phased out as income grows.
You should run the numbers
on Form 8615 and Form 8814 to guarantee that you, and your child, pay the
least possible tax on the youngster's investment earnings. If you have more than
one child with unearned income, you must repeat this process for each child.
Also be sure
to know the IRS instructions
on determining your child's
age. The IRS tax year is slightly
different than the calendar
year when it comes to the
|IRS' kiddie tax ages
|Jan. 1, 1991
|Jan. 1, 1990
|Jan. 1, 1985
ages of your children are
important because they determine
whether the child is subject
to the kiddie tax, as well
as whether Form 8615 must
be filed by the child or whether
Form 8814 can be filed by
his or her parents.
And remember that for kiddie-tax age purposes, only investment earnings are taken into account. Wages and other earned income received by a child of any age are taxed at the child's normal rate.
on filing requirements for
children can be found in IRS
Publication 929, "Tax
Rules for Children and Dependents."
|-- Updated: March 31, 2009