OK Kiddies, Let’s Pay Some Taxes
Congress (our favorite scapegoat) in its infinite wisdom decided in 1986 that in certain circumstances your children should pay taxes, not using rates that normally apply to them, but instead using the rates and brackets of their parents.
Okay, before you go off ready to descend on Washington like the Tea Party, if you think about it, it kind of makes sense (remember, I said kind of).
You see, the reason for this complication added to the tax code was to prevent parents whose incomes place them in high tax brackets from “shifting” income to their children who otherwise would be in much lower tax brackets.
Darn those tax planners for thinking up that strategy! The solution has come to be known as the Kiddie tax.
So what exactly is a "Kiddie"?
Well, it started off limited enough, only applying to kiddos under age 14 at the end of the year, and so it was for close to 20 years.
Then the tinkering began and for a couple of years the age was changed to under 18. However, beginning in 2008, things changed dramatically, and now the tax potentially applies up through age 23 if your child is a full-time student!
The Kiddie tax is figured using IRS Form 8615. Basically, if the parent's tax rate is higher than the child's, which is almost always the case, that income is taxed at the parent's rate.
Now here's where it gets complicated for a variety of reasons!
First, if there is more than one child subject to the tax, the unearned income of other children must also be taken into account.
Also, with different tax rates in effect for certain dividends and capital gains, these amounts need to be recalculated.
For instance, a child could be in the 0% bracket for capital gains and qualified dividends, but her parents are in the 15% bracket. The tax on the kid's capital gains and qualified dividends will have to be calculated separately for the Kiddie tax using the higher 15% tax rate, and this will have to be done for the parents, the child and any other children of the parents who are subject to the Kiddie tax.
Form 8615 must be filed BY THE CHILD if all of the following apply:
1. Investment income exceeds $1,900 (for 2011).
2. The child is required to file a return (see return instructions to determine this).
3. At least one parent is alive at the end of the year.
4. The child does not file a joint return.
5. They are either: Under age 18 at the end of the year, Age 18 at the end of year but their earned income was not more than 1/2 of their support, Between the ages of 19 and 23 at the end of the year and a full-time student and their earned income was not more than 1/2 of their support.
Simple enough?
By the way, there are some cases where the child's income and resulting tax can be reported directly on the parent's return, thereby eliminating the need for the child to file. However, many times this has negative effects to the parents that result in an overall higher tax burden, so be wary of this.
There are frankly not a lot of options for minimizing or eliminating the Kiddie tax, if it appears your family will be subject to it. Here are a few ideas:
1. Invest in tax-free investments, such as municipal bonds, section 529 plans, etc., or in tax-deferred investments that won't throw off taxable income until after the age limits are reached, such as zero coupon bonds, savings bonds, etc.
2. Consider investments designed to be held for long-term appreciation rather than current income, intending not to sell until after the trigger age.
3. Education credits can be used by students against the Kiddie tax, but only when they can't be claimed as a dependent by the parent.
4. If a child between the age of 18 and 23 has earned income of more than 1/2 of their support, the Kiddie tax doesn't apply. With a little planning, earned income possibly can be maximized to meet the support requirement. For instance, student loans in the name of the student are considered to be support for which the child pays. Also, self-employed parents can pay wages to students for services they perform, as long as they are “reasonable” wages.
