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Does Your Child Need to File a Tax Return?

Children have always been able to earn some of their own money. And, of course, since the IRS wants to make sure that all income is reported — and proper taxes are paid — it is important to understand your kids might need to pay taxes.

At any rate, even if your child doesn’t have to pay taxes, he or she may have to file a tax return. If your child has earned income, or if your child has earned interest and dividends from investments you made for them, you might need to file a tax return for your child.

Income Requirements for a Child Tax Return

Determining whether or not your child should file a tax return is based on his or her income, rather than his or her age or tax bracket [3]. As with other income-related issues related to taxes, the income requirements change based on inflation. For 2011 (the tax return filed in April of 2012), your child needs to file a tax return if any of the following apply:

Keep track of your child’s income; it is likely to be reported on various forms, but it helps if you have your own records. Remember, too, that if you decide to pay wages to your child [4] that this can count as income for him or her.

How to File Your Child’s Tax Return

You can file your child’s tax return one of two ways: With your tax return, or separately.

As long as your child’s income is less than $9,500, and solely from dividends and interest, it can be reported as part of your tax return. Your child must be under 19, or a full-time student under the age of 24 for this rule to apply. Your child’s income is reported on Form 8814. However, you should understand that if you report your child’s income this way, it will be added to your dividend and interest income, and can result in higher capital gains taxes.

If your child has earned income or self employed income, though, he or she is required to file a separate tax return. If the income is higher than $9,500, and if your child doesn’t fall within an age limit, a separate return needs to be filed. Even if your child qualifies to file as part of your tax return, you can still choose to file a separate one — especially if you are concerned that your taxes could increase because of it.

What about the Kiddie Tax?

What is known as the kiddie tax [5] applies to unearned income. The first $950 of your child’s income is untaxed. The next $950 is taxed at the child rate of 10%. Once your gets beyond $1,900, though, that money is taxed at your marginal tax rate. It’s important to understand how this works so that you can work out how to best arrange your finances — and your child’s finances — to improve your tax efficiency.

(Photo: GoodNCrazy [6])