When Does the Kiddie Tax Apply to a Child?

The kiddie tax is a set of rules designed to prevent parents from lowering their family tax liability by shifting investment income to their children, who are in lower tax brackets. The tax accomplishes this by applying the parents’ higher tax rate to a child’s unearned income once it surpasses a certain annual limit. These regulations are not intended to penalize children for modest savings. Instead, they are targeted at situations where the amount of unearned income is large enough to suggest a tax-motivated transfer of assets from a parent to a child.

Criteria for a Child Subject to the Tax

For the kiddie tax to apply, an individual must meet specific criteria for age, financial support, and tax filing status. The primary test is age, which applies to children under age 18 at the end of the tax year. The rules also extend to children who are age 18 and full-time students ages 19 through 23, but only if their earned income does not exceed half of their own support for the year. A full-time student is someone enrolled for some part of at least five calendar months.

Beyond age, two other conditions must be met. The child must not have provided more than half of their own support for the tax year. Additionally, the child cannot file a joint tax return with a spouse for the year.

The Unearned Income Threshold

The financial trigger for the kiddie tax is based on a child’s “unearned income.” This category includes all income not received for services performed, such as interest from bank accounts, dividends from stocks, and capital gains from the sale of assets. It also encompasses other passive income sources like royalties and rental income. It is important to distinguish this from “earned income,” which is compensation a child receives from working a job and is taxed at the child’s own rates.

For the tax to apply, the child’s total unearned income must exceed a specific amount set by the IRS, which is adjusted periodically for inflation. The kiddie tax rules are triggered if a child’s unearned income is more than $2,700.

How the Kiddie Tax is Calculated

Once it is determined that the kiddie tax applies, the calculation follows a specific, tiered formula. The first portion of the child’s unearned income, $1,350, is not taxed at all, corresponding to a portion of the standard deduction for dependents. The next $1,350 of unearned income is taxed at the child’s own marginal tax rate, which is often 10%.

Any unearned income that exceeds $2,700 is considered “net unearned income” and is subject to the kiddie tax. This remaining amount is taxed at the parents’ highest marginal tax rate. For example, if a child has $5,000 of unearned income, the first $1,350 is tax-free, the next $1,350 is taxed at the child’s rate, and the remaining $2,300 is taxed at the parents’ rate.

Methods for Reporting the Tax

There are two methods for reporting the tax to the IRS. The standard approach is for the child to file their own tax return using Form 1040. When this method is used, Form 8615, “Tax for Certain Children Who Have Unearned Income,” must be completed and attached. This form is where the detailed calculation of the tax is reported, using the parents’ tax information to determine the applicable rate.

Alternatively, parents may have the option to report the child’s income directly on their own tax return using Form 8814, “Parents’ Election To Report Child’s Interest and Dividends.” This option is only available if all the following criteria are met:

• The child’s income must consist only of interest and dividends.
• The child’s gross income must be less than $13,500.
• The child cannot have paid any estimated taxes for the year.
• No federal income tax can have been withheld from their income.

While this election avoids filing a separate return for the child, including this income can increase the parents’ adjusted gross income, potentially affecting other tax calculations on their return.