Minors Taxed at Parents' Rates

The kiddie tax

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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 2009, that amount is $950, so the kiddie tax begins to apply when your child has more than $1,900 in investment income.

Your child can still owe regular income tax with less than $1,900 in income. This is merely the threshold amount of investment income for the special kiddie tax.

Children affected by the rule

The application of the kiddie tax depends partly on your child's age as of the end of the year. For this purpose a child born January 1 is treated as if he or she reached the age of that birthday on December 31 of the previous year. We now have different rules for four different age groups:

• Until the year your child turns 18, the kiddie tax applies automatically if your child has the amount of investment income described above.
• In the year your child turns 18, the kiddie tax applies unless your child's earned income is more than half his or her overall support. Note that "earned income" for this purpose includes money your child earns by working but not investment income.
• For the year your child turns 19 through the year your child turns 23, the kiddie tax applies to a child who is a full-time student during any part of at least five months during the year unless the child's earned income is more than half his or her overall support. In other words, your child has two ways to avoid the kiddie tax: earn enough income or stop being a full-time student.
• 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.

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

How it works

If your child has more than $1,900 in investment income, the tax is figured according to a special calculation. The first $1,900 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 2009 your child has $2,900 of interest income and no other income. The first $950 of investment income escapes taxation: your child's standard deduction takes care of that. The next $950 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 $950 plus 28% of $1,000, for a total of $375.

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).