When Does the Kiddie Tax Apply to a Child’s Income?

The “kiddie tax” is a provision in tax law designed to prevent high-income individuals from reducing their tax liability by transferring investment assets to their children, who might be in a lower tax bracket. This measure ensures that certain unearned income of a child is taxed at the parent’s marginal income tax rate, rather than the child’s typically lower rate. The fundamental purpose of this tax is to maintain fairness in the tax system by limiting the ability to shift income strategically. It addresses situations where income from investments, such as stocks or bonds, might otherwise be taxed at a significantly reduced rate if held directly by a minor.

Identifying Who is Subject to the Kiddie Tax

The application of the kiddie tax depends on specific criteria related to a child’s age, financial support, and relationship to the taxpayer. Generally, a child is subject to the kiddie tax if they are under 18 years old at the end of the tax year.

The rules also extend to individuals who are 18 years old at the end of the tax year, provided their earned income does not exceed more than half of their own financial support for the year. Furthermore, the kiddie tax can apply to full-time students who are at least 19 but under 24 years old at the end of the tax year, if their earned income also does not exceed more than half of their support.

The child must be a natural child, adopted child, stepchild, or foster child of the taxpayer to fall under these provisions. At least one of the child’s parents must be alive at the end of the tax year. The child must also be required to file a tax return and cannot file a joint tax return for the year.

Understanding Unearned Income and Its Thresholds

The kiddie tax specifically targets “unearned income,” which is income derived from passive sources rather than from active work or services. This category includes various forms of investment returns, such as interest, dividends, and capital gains from asset sales, rents, royalties, and income distributed from trusts.

It is important to distinguish unearned income from “earned income,” which encompasses wages, salaries, and professional fees received for services performed. Earned income is not subject to the kiddie tax and is taxed at the child’s own tax rates.

The kiddie tax is triggered when a child’s unearned income surpasses specific thresholds. The initial $1,300 of a child’s unearned income is generally tax-free. This amount effectively functions as a standard deduction for dependents, which is the greater of $1,300 or the child’s earned income plus $450, up to the basic standard deduction for their filing status. The next $1,300 of unearned income is taxed at the child’s own tax rate. Any unearned income exceeding $2,600 becomes subject to the kiddie tax. This means that amounts above this specific threshold are taxed at the parents’ marginal income tax rate, which is typically higher than the child’s individual rate.

How the Kiddie Tax is Calculated

The calculation of the kiddie tax involves determining the portion of a child’s unearned income that will be taxed at the parent’s rate. This specific amount is referred to as “net unearned income.” To arrive at this figure, the initial $2,600 of the child’s unearned income is subtracted from their total unearned income. This $2,600 threshold accounts for the initial tax-free amount and the portion taxed at the child’s rate.

Once the net unearned income is determined, it is generally added to the parents’ taxable income for calculation purposes, and then taxed at the parents’ marginal income tax rate. In situations involving divorced parents, the tax rate of the parent with whom the child resided for the majority of the year is typically used. If parents are deceased, the highest individual tax rate applies. Any earned income the child has, such as wages from a part-time job, continues to be taxed at the child’s own tax rates.

Tax Filing and Reporting

When a child’s income is subject to the kiddie tax, there are two primary methods for reporting it to the Internal Revenue Service. The most common method involves the child filing their own tax return and attaching Form 8615, “Tax for Certain Children Who Have Unearned Income.” This form is specifically designed to calculate the tax on the child’s net unearned income using the parent’s tax rate.

To complete Form 8615, the child’s unearned income, along with certain information from the parents’ tax return (such as their tax rate and filing status), is required. This ensures the correct application of the parent’s marginal tax rate to the child’s applicable unearned income. The calculated tax from Form 8615 is then transferred to the child’s Form 1040.

Alternatively, parents may elect to include the child’s income on their own tax return by filing Form 8814, “Parents’ Election to Report Child’s Interest and Dividends.” This election is generally available if the child’s gross income was less than $13,000 and consisted solely of interest and dividends (including capital gain distributions). Using Form 8814 can simplify the filing process by consolidating tax reporting for the family. However, parents should consider that reporting the child’s income on their own return may increase their adjusted gross income, which could affect certain deductions or credits. A separate Form 8814 must be filed for each qualifying child whose income the parents choose to report.