The kiddie tax was created in 1986. The kiddie tax was implemented to prevent parents from shifting investments or unearned income from their high tax brackets into their child’s lower tax bracket. Kiddie taxes work by taxing children’s unearned investment income at the parent’s tax rate rather than the lower rate for children.
For kiddie tax purposes, “unearned” or “investment” income is any income besides the child’s wages and earned salaries. Unearned income includes bank account interest, investment income, capital gains, and stock/mutual fund dividends. A parent who transfers such assets to their child must pay the kiddie tax.
How Does the Kiddie Tax Work?
The kiddie tax kicks in if the child’s net unearned income reaches over $1,900. The first half of this ($950) isn’t subject to taxes at all. The second $950 is taxed at the children’s rate of 5% or 10% depending on the amount.
Any unearned income over $1,950 is taxed at the parent’s income tax rate, which may be anywhere from 10-35%, depending on their income.
Who Does the Kiddie Tax Apply To?
The kiddie tax only applies to children who are:
- Unmarried and under 18 years old
- Under 18 years old with an earned income at least equal to half of the child’s support for the given tax year
- Full-time students over 18 years old but not yet 24 at the end of the tax year, AND having an earned income of at least equal to half of the child’s support for the given tax year
How Is the Kiddie Tax Calculated?
Under the kiddie tax rules for 2022, the child’s unearned income under $1,100 is not taxed. The next $1,100 is taxed at the child’s tax rate. Any unearned income exceeding $2,200 is taxed at the parent’s tax rate.
A child could file a tax return, or the parent may elect to report their child’s interest, ordinary dividends, and capital gains distributions on their own tax returns. Either way, the income will be taxed at the parent’s rate.
When Does a Child Need to File a Separate Tax Return?
The rules for filing separate tax returns depend on how much the child earned from working and how much was earned from investment income.
Children who earned more than $12,400 in 2021 from earned and unearned income must file their own income tax returns. If the child’s only income is from interest, dividends, or capital gains distributions, and totals less than $11,000, then the parents may be able to include the child’s income on their own tax returns. Parents who wish to include their child’s income on their own tax returns must complete a Form 8814.
There are other requirements for a child’s tax return to qualify to be included on a parent’s tax return. There must be no withholdings or estimated tax prepayments for the child. The child has to be under the age of 19. The child must be under the age of 24 if they are a full-time student and do not file a joint return with a spouse.
What Are the Pros and Cons of Reporting the Child’s Income on the Parent’s Tax Return?
If eligible, there are pros and cons to reporting the child’s income on the parents
The advantage is convenience, but there are disadvantages, too. Potentially exposing the child’s income to net investment income taxes, losing a child’s itemized deductions, and increases on capital gains and qualified dividends taxes are all potential cons of reporting a child’s income on a parents’ tax return.
How Can the Kiddie Tax Be Avoided?
There are a few ways that parents can contribute to their children without being subject to the kiddie tax. These include:
- Section 529 “Qualified Tuition Plan” (QTP): Contributions to QTP’s aren’t tax-deductible, so they aren’t subject to the kiddie tax. In addition, earnings aren’t counted as taxable income, so long as they are used for higher education costs. Withdrawals from such accounts need to be used for qualified educational purposes
- Education Savings Account (ESA): These are similar to QTP’s, except they can be used for elementary and secondary school expenses. Contributions to ESA’s aren’t subject to kiddie taxes
- Employment: Another option is to hire your child if you own a business. Any wages you pay your child won’t be subject to the kiddie tax.
Many disputes and violations involving kiddie taxes can be avoided through proper planning and consulting with qualified professionals. However, intentional conduct aimed at avoiding tax laws can lead to legal consequences for the parent. These legal consequences can include fraud charges and other types of tax-evasion-related violations, resulting in possible fines or jail sentences.
What Is the History of the Kiddie Tax?
The original kiddie tax law only covered children under the age of 14. Children under the age of 14 cannot legally work, which means that any income they receive usually comes from dividends or interest from bonds. However, tax authorities at the time realized that some guardians would take advantage of the situation by giving stock gifts to their 16-to-18-year-old children.
Today, the kiddie tax is imposed on individuals 18 years or older whose investment and unearned income is higher than an annually determined number. The IRS taxes any income exceeding the predetermined threshold at the parent’s tax rate. The Tax Cuts and Jobs Act of 2017 temporarily changed the kiddie tax to use tax rates that apply to estates and trusts rather than the parents’ tax rate.
However, the Further Consolidated Appropriations Act of 2020 retroactively changed kiddie taxes back to the parent’s tax rate. For 2018 and 2019 tax returns, taxpayers could either use the estate tax rates or the parent’s tax rate for calculating the kiddie tax. From 2020 and beyond, the parent’s tax rate applies.
If your family paid the kiddie tax in 2018 or 2019, you might be eligible for a refund. If you calculated your child’s liability using estate and trust tax rates in 2018 or 2019, you have the option to file an amended return using your tax rate for your child’s unearned income. Paperwork and associated preparation costs may come along with filing for the potential refund.
Do I Need a Lawyer for Assistance with Kiddie Tax Laws?
Kiddie tax laws are relatively new and can sometimes be confusing to understand. Legal questions and concerns should be directed to a qualified tax lawyer in your area. It’s in your best interests to hire an experienced attorney to help you with your tax inquiries. Kiddie tax laws aim to prevent U.S. tax system abuses and are strictly enforced.
The kiddie tax laws have changed various times throughout the last 40 years. The kiddie tax rules have changed with presidencies. If you are considering using the kiddie tax laws, use LegalMatch’s services to find an experienced tax lawyer in your area. Our services allow you to narrow down your search for an attorney near you.
By using LegalMatch, you allow yourself to find the right attorney for you by selecting the specific issues in your case. Each kiddie tax case is different. If you’d like to have the best guidance available to you while navigating these laws, use LegalMatch today.