Minors Taxed at Parents' Rates

The kiddie tax

By Kaye A. Thomas
Updated May 31, 2007

Certain children that have investment income above a threshold amount have to pay tax at their parents' rates.

At one time, wealthy families could save a great deal of money by transferring investment assets to minor children. Tens of thousands of dollars in investment income produced by those assets would be taxed to the children at the lower rates that apply to individuals who have relatively little income. Congress decided to limit the tax benefit from shifting income to children, so we now have a law that says certain children that have more than a small amount of investment income have to pay tax at their parents' tax rate.

Originally this rule applied to children under 14 years of age, and it became known as the kiddie tax. Congress moved the age limit up to 18 as of 2006, and beginning in 2008 it can apply to students until they reach age 24, making the term kiddie tax something of a misnomer. See below for details on who is affected.

Income Threshold

You don't have to worry about this rule until your child has investment income greater than a threshold amount, which is two times the amount allowed as a standard deduction for a dependent who has only investment income. For 2007, that amount is $850, so the kiddie tax begins to apply when your child has more than $1,700 in investment income.

Your child can still owe regular income tax with less than $1,700 in income. This is merely the threshold amount of investment income for the special kiddie tax.

Children Affected by the Rule

For 2007, the rule does not apply if your child reached age 18 by the end of the year. (Before 2006 the rule applied until age 14.) For purposes of this rule, a child born January 1 is considered age 18 on December 31 of the year preceding the 18th birthday. As a result, a child 18 or older gets the full benefit of the lower tax rates, even when investment income exceeds the threshold amount.

Beginning in 2008 we have a confusing new rule that can extend the kiddie tax to older children, depending (from age 18 through 23) on how much earned income they have, and whether they're full-time students. Here's how it works.

Beginning with the year your child turns 18, the kiddie tax doesn't apply if your child's earned income is more than half his or her overall support. (It doesn't matter whether the earned income is actually used for the child's support, so long as the amount of earned income is more than half the amount of the child's support.) This rule uses the same broad definition of support that applies under the rules for claiming personal exemptions (which includes, among other things, school tuition). Earned income includes salaries and wages, commissions, professional fees and tips, among other items. This rule uses the same definition as the exclusion for foreign earned income, so if you need details you can consult the discussion of earned and unearned income in this IRS publication.
Beginning with the year your child turns 19, the kiddie tax doesn't apply if your child isn't a full-time student. The definition used here says your child is considered a full-time student for the year if he or she is a full-time student during any part of at least five months during the year.
Beginning with the year your child turns 24, the kiddie tax doesn't apply at all, even if your child is living off investments and plugging away at that PhD.

As a result, we have three different sets of rules for determining whether the kiddie tax applies. Prior to the year your child turns 18, earned income and status as a student don't matter. For the year your child turns 18 (and only that year), earned income matters but student status doesn't. From the year your child turns 19 up to but not including the year your child turns 24, there are two ways to avoid the kiddie tax: earn enough income, or stop being a full-time student.*

The kiddie tax doesn't apply if your child is married filing jointly.

How It Works

If your child has more than $1,700 in investment income, the tax is figured according to a special calculation. The first $1,700 of investment income is still taxed at the child's lower rates, but any additional investment income is taxed at the parents' rates.

Example: In 2007 your child has $2,700 of interest income and no other income. The first $850 of investment income escapes taxation: your child's standard deduction takes care of that. The next $850 is taxed at the child's rate of 10%. That leaves $1,000 to be taxed at whatever rate would apply if this income were added to the income reported on your tax return. Suppose you're in the 28% tax bracket. The tax on your child's income would be 10% of $850 plus 28% of $1,000, for a total of $365.

Even though the tax is calculated at the parents' rate, it is still the child that owes the tax, not the parents.

How to Report

There are two ways to apply the parents' rate to the child's income.

One is to include the income on the parents' return. This option isn't always available, or you may decide it isn't best for you even if it is available. Click here for more information.
The other way is to report the income on a return for the child, but with a special calculation on IRS Form 8615 (see link below for forms and publications).

* The original version of this article didn't properly reflect the special treatment that applies for one year at age 18. Thanks to Ed Zollars for setting me straight.