Net income provides a more accurate account of the financial status. Here’s why.
What is a kiddie tax?
The kiddie tax is a special Internal Revenue Service (IRS) rule that seeks to prevent certain taxpayers from avoiding taxes by giving investments to their children. The kiddie tax is levied on a child’s unearned income that is derived from sources unrelated to employment, such as interest payments and dividends. For the purposes of this tax, a child is defined as being under the age of 18, or under the age of 24 if a full-time student.
The kiddie tax was first introduced in Tax Reform Act of 1986, and the rules were updated in 2005. The principle behind the tax was to close a loophole whereby parents were able to give investments to their children and reduce their own tax liabilities. The kiddie tax requires that a child’s unearned income above a certain threshold is taxed at the marginal rate of the parent with the greater income.
The threshold at which this tax kicks in is $2,100 for 2017. Any income above $6,300 earned by a child through part-time employment is taxed separately.
When a child’s unearned income is greater than $2,100, parents have two choices for filing tax returns. They can file a child’s tax return or they can include the child’s income on their own return. If the child’s income exceeds $10,500, the law requires that a separate tax return be filed for the child. Apart from this, there are several other conditions that may mandate that a return is filed for the child, including age and cost of support.
Kiddie tax examples
Parents often invest money or purchase stocks in their child’s name with the intention of saving for the child’s education. This has the benefit that the investments are in the child’s name should anything happen to the parents. Once unearned income exceeds $2,100, parents have the choice of filing separately or jointly. Before deciding, it’s a good idea to compare the taxes due using IRS forms 8615 and 8814 and determine which is best. Irrespective of the approach, the tax is always paid by the child.
Do you know how much kiddie tax your child needs to pay? Find out using our tax calculators.