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Kiddie Tax

Stevenson G. Smith, CPA

July 20, 2010

At one time, wealthy parents could transfer investment assets to their children and save money by having the investment income taxed to the children at a much lower tax rate. Congress has limited this tax benefit, and now the unearned income of children until the age of 24 is affected by what has become called the kiddie tax. 

Unearned income includes dividends, interest and capital gains.  The child is allowed $950 in unearned income before the parent’s tax rate is applied to the unearned income.  The child has a standard deduction of $950, effectively allowing $1,900 in unearned income exempt from income taxes.  This law was passed in order to eliminate the possibility of parent’s transferring investments into their children’s names and having the income taxed at a much lower rate. 

For the kiddie tax to apply they must fall into one of the following categories:

  • If the child is younger than 18 years of age, the kiddie tax applies if the child has more than $1,900 of unearned income.
  • If the child is 19 and the child’s earned income is half (or less) of the child’s support cost, then the kiddie tax applies to their unearned income.  Note that earned income for this purpose includes money the child earns by working, not investment income.
  • If the child is between 20 and 24, the child’s earned income is half (or less) of the child’s support cost, and the child is a full-time student, the kiddie tax applies to their unearned income.
  • In the year the child turns 24, the kiddie tax no longer applies.

Example:  In 2012 a 14-year old child has $3,000 of interest income and no other income.  The first $950 of unearned income is tax free,  the next $950 excluded due to the child’s standard deduction. That leaves $1,100 to be taxed at whatever rate would apply if this income were added to the income reported on the parent’s return.

There are two choices to apply the parent’s rate to the child’s income. (1)  Include the income on the parent’s return or (2) Report the income on a return for the child, but with special calculations on IRS Form 8615.

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