Understanding the Child Tax Rate for Your Children’s Investment Income

Investment income is subject to federal taxes. This includes income earned for investments in a child’s name. It is important for parents of children who have investment income to understand how this income should be reported when filing your annual tax return.

There are several factors which must be considered which determine how the income is reported and the rate at which it will be taxed.

The “Kiddie” Tax

As with all things tax related, how a child’s investment income is taxed varies depending on the age of the child and the amount of earnings in question. Children are taxed at a lower tax rate than that of an adult. In 1986 a “kiddie” tax was created to prevent parents from holding investments in a child’s name for the purpose of avoiding higher tax rates. With the addition of the kiddie tax, investment income earned in a child’s name was subject to taxation at various levels. Earnings were divided into portions some of which were tax free, others taxed at the child’s lower rate and the remainder taxed at the parent’s rate. In 2006, the Tax Increase Prevention and Reconciliation Act increased the age at which a child can claim the lower tax rate from 14 to 18. This resulted in earning being taxed at the parent’s rate until the child turned 18 at which time the lower child rate would kick in. Other changes increased the age again for the 2008 and 2009 tax years preventing young investors from taking advantage of the younger rate until they were 19. If aged 19-23 and a full-time student, investment income continues to be taxed at the parent’s rate.

How To Handle Investment Income On Tax Return

To ensure investment income is reported and taxed properly the IRS provides the following tips to handle investment income when filing a return:

• Remember that earned income from a child is separate from investment income. Earned income is always taxed at the child’s lower rate. Income from investments such as dividends, interest, capital gains and any other unearned income may be subject to taxation at a higher rate.
• Determine rate by child’s age. If investment income exceeds $1,900 it may be taxed at the parent’s rate if the child’s age meets the following requirements. If the child is under age 18 at the end of the year. If a child is 18 at the end of the year and earned income that did not exceed half of their support. Full-time students age 19-23 who have not earned income to equal half of their support are also taxed at the parent’s rate.
• To determine the tax on a child’s investment income at the parent’s rate, Form 8615 can be used and attached to the child’s federal income tax return. Form 8814 may be used if a parent meets certain conditions which allow for the parent to include the child’s income on their tax return.

It is very important to understand how to handle investment income earned by your child when filing your tax return. Any parent with questions regarding investment income and tax rates should contact the IRS or a professional tax preparer to better understand the process.