The kiddie tax is a special tax on children under age 18 who have net investment income over $2,000. It became part of the tax law when the 1984 Tax Reform Act was signed by President Reagan. The law was designed to prevent high income taxpayers from registering investments and other property producing investment income in the name of their children and having the income reported on the child’s tax return which would be taxed at a much lower rate than the parents.
The child’s net investment income can be reported in two ways: (1) on the parents return using form 8814 or (2) on the child’s return using form 8615. If it is reported on the child’s return, the net investment income over $2,000 will be taxed at the parents highest tax rate.
The kiddie tax applies if ALL the following requirements are met [J.K. Lasser’s Your Income Tax 2014].
(1) The child was (a) under age 18 at end of the tax year., (b) was age 18 at the end of the tax year and did not have earned income exceeding half of his or her support for the year, (c) was a full-time student during 2013 and at the end of the tax year was age 19 through 23 and did not have earned income exceeding half of his or her support for the year. The IRS considers a person whose birthday falls on January 1, to be that age at the previous December 31. Example: If your son will be 18 on January 1, 2014, the IRS considers him to be 18 on December 31, 2013. For (a) and (b) the dependency exemption rules are used to determine full-time student status and support.
(2) The child had more than $2,000 net investment income. This amount is increased if the child has itemized deductions exceeding $1,000 that are directly connected to producing investment income (e.g., broker advisory and financial planner fees).
(3) The child is married and files a separate return.
Computing the Kiddie Tax on the Child’s Return
[J.K. Lasser’s Your Income Tax 2014].
Parents Income and Tax Reported
On Form 8615 (a copy is posted on TaxConnections in my Tax Library), the parents taxable income and regular income tax is entered first. The income used depends on the parents filing status and which parent has custody. If a joint return is filed, joint taxable income and regular tax is used. If separate returns are filed, the larger amounts of the parents is used. If the parents are legally separated or divorced, and they share custody, the income and tax of the parent who has custody the greater part of the year is used. If the custodial parent files as head of household, the income and tax of the custodial parent is used. If the parents were never married and live together with the child, the one with the largest amount is used. If the unmarried parents do not live together, the amounts of the custodial parent is used.
Computing the tax-one child
On Form 8615, the parents taxable income is added to the child’s net investment income exceeding $2,000. The tax is then figured on this amount based on the parent(s) filing status. The excess of the tax on the combined amount over the parent(s) separate tax is the tax attributable to the child’s net investment income exceeding $2,000 (the kiddie tax). The kiddie tax plus the tax on the child’s other taxable income is the total tax for the child.
Computing the tax-more than one child
If more than one child is subject to the kiddie tax, a separate Form 8615 is filed for each child. On each form the net investment income of all children is entered. The tax is then allocated to each child based on each child’s proportionate share of total net investment income.
The Kiddie Tax on the Parents Return
[J.K. Lasser’s Your Income Tax 2014].
Form 8814 (a copy is posted on TaxConnections in my Tax Library), is used for this option. This option can be used if ALL the following tests are met [J.K. Lasser’s Your Income Tax 2014].
(1) The child was under age 19, or age 24 if a full-time student at the end of 2013.
(2) The child’s only income is from interest and dividends (including mutual fund capital gain distributions and Alaska Permanent Fund dividends).
(3) The child’s total interest and dividends are over $1,000 but less than $10,000.
(4) 2013 estimated tax payments were not made in the child’s name and social Security number and there were no overpayments from the child’s 2012 return applied to his or her estimated tax.
(5) The child was not subject to 2013 back-up withholding.
Computing the tax
On Form 8814, determine the portion of the child’s qualified dividends and capital gain distributions that the parent reports on their return if they are eligible for the preferential tax rate on qualified dividends and net capital gains. The balance of the child’s net investment income over $2,000 is reported as other income on line 21 of Form 1040. An additional tax of the lesser of $100 or 10% of your child’s income over $1,000 is then computed. This amount will be included in the parents regular income tax on line 44, of Form 1040. If form 8814 is used, Forms 1040A and EZ cannot be used. If the parents file separate returns, or are divorced, separated, unmarried, or living apart for the last six months of the year, then the return of parent whose income would be reported on Form 8615 is used to report the child’s net investment income.
Tax planning for the Kiddie Tax
Starting in tax year 2013, the Obama Care law imposed an additional .9% Medicare tax on wages above $200,000 ($250,000 married filing joint) and a 3.8% tax on net investment income for taxpayers with AGI above $200,000 ($250,000 married filing joint). As a result, if the child’s investment income is reported on the parents return, it will be subject to these additional taxes. To prevent this, parents should report the investment income on the child’s return. The child will most likely not have AGI exceeding $200,000, so the additional taxes will not apply. Depending on the amount of net investment income and the parents marginal tax rate, reporting the income on the child’s return may result in less tax on total household income.
Also, by reporting the child’s net investment income on the parents return this increases their AGI which will reduce certain itemized deductions (e.g., medical, casualties, miscellaneous)that are reduced by a percentage of AGI, and increase the phase out of exemptions and total itemized deductions for certain high income taxpayers. It could also reduce certain tax credits subject to income limits (e.g., the dependent and child care and education credit). Other deductions that may be reduced are regular IRA contributions and student loan interest. The alternative minimum tax could also increase because interest income from private activity bonds is subject to the alternative minimum tax.
An additional factor is the penalty for underpayment of tax. This could occur if the parent(s) did not take their child’s net investment income into account for computing their estimated tax or withholding tax payments. If a parent expects to include their child’s net investment income on their return next year, they should increase their estimated tax payments or withholding tax to avoid an under payment penalty.