What is the Kiddie Tax?

It’s always a good idea to set aside some funds for your child’s future. But if you’re thinking of placing a substantial amount under their name, know that it won’t be exempted from taxes. The kiddie tax applies to children of a certain age who have unearned income. Whether from savings or investments, it has tax implications if it reaches a certain amount.

This tax law prevents parents from transferring their assets to their children’s names to take advantage of paying lower tax rates. If you want to know more about the rules and implications of the kiddie tax, read more below.

To Who Does the Kiddie Tax Apply?

The kiddie tax applies to individuals that have unearned income that exceeds $2,500 if they’re in the age range of:

Under 18 years old at the end of the tax year.
18 years old and don’t have earned income that’s more than 50% of their child support.
A full-time student that’s between 19 to 24 years old that doesn’t have earned income that’s more than 50% of their child support.

Child support covers food, shelter, clothing, medical care, and education. But if they’re over 18 and file a joint return within the tax year, they’re no longer subject to the kiddie tax.

Unearned income includes dividends, taxable interest, capital gains, taxable scholarships, rents, royalties, and fellowship grants. But it doesn’t apply to earned income from wages or salaries they receive.

But if their only income comes from interest, dividends, and capital gains distributions that total less than $11,500, you may also elect to include it on your own return rather than file a separate return for your child.

How Does the Kiddie Tax Work?

The kiddie tax has three thresholds, and it applies as follows:

The first $1,250 of unearned income is covered by the standard deduction of the kiddie tax, so it remains tax-free.
The next $1,250 is subject to the child’s marginal tax rate.
Any amount exceeding $2,500 for the 2023 tax year will be taxed at their parent’s marginal tax rate.

Does my Child Need to File their Own Tax Return?

In a sense, yes. You need to file a separate tax return in your child’s name if the amount of unearned income they have exceeds $2,500.

You may have better chances of getting an older child or teenager to file their own tax form compared to a younger one. But you can always teach them early by going through the process with them. Otherwise, you can file it on their behalf until you think it’s age-appropriate to do it by themselves.

If you and your partner have a joint return, you may include it in your report. But if you file separately, you can report your child’s unearned income on the return of the parent with the highest taxable income.

How do you Calculate Kiddie Tax?

To calculate the kiddie tax, you need to determine their taxable income first by using the formula:

Net Earned Income + Net Unearned Income – Standard Deduction = Taxable Income

The standard deduction is the greater amount between $1,250 or the sum of their earned income plus $400.

For example, your child has $7,000 from working retail and received $5,000 interest income that they inherited from their grandparent.

Since their earned income is $7,000, their standard deduction would be $7,400. To get their taxable income, you’ll need to use the formula above:

$7,000 + $5,000 – $7,400 = $4,600

Since they have $4,600 of taxable income, the first $1,2500 is tax-free. This leaves the next $1,250 of the amount subject to your child’s tax rate, while the remaining $2,100 is subject to your tax rate.

How do you Report Kiddie Tax?

To report your child’s unearned income, you need to fill up Form 8615 (Tax for Certain Children Who Have Unearned Income) and attach it with their Form 1040.

But if your child’s gross income for the year is less than $11,500, you may elect to report it with your tax return by filling up Form 8814 (Parents’ Election To Report Child’s Interest and Dividends) and attaching it to your own Form 1040.

Can you Avoid the Kiddie Tax?

You can avoid the kiddie tax by reducing the amount of unearned income that’s under your child’s name. You can also invest $6,500 a year in a Roth IRA for kids for tax-free growth as long as you follow distribution rules.

You can also invest their unearned income in a 529 savings account to help pay for their education. It also grows and withdraws tax-free as long as you use the funds for qualified education purposes.

Need Help with Your Taxes?

If you need assistance with calculating or filing your child’s kiddie tax, Lear & Pannepacker can help. They have a team of experienced CPAs and accountants ready to handle your account. They also offer other financial services, such as auditing, bookkeeping, business advisory, and financial planning. So if you have questions or inquiries, feel free to contact their team now.