Kiddie Tax: Taxes on Your Child’s Investment Income

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Kiddie TaxInvesting is one of those lessons that your children can learn. Teens can begin learning about investing, and the ways it can benefit them. However, anytime your child has an investment, he or she has the potential to make money. Of course, as with most income, the government wants its cut. So, your child will have to pay taxes on the income received from investments, dividends and interest.

The tax on children’s investment income is known as the Kiddie Tax. If you are thinking of sheltering some of your investment assets as a child’s, or if your child has done pretty well with his or her investments during the year, you need to be aware of the basics related to the Kiddie Tax:

When Do Children Pay Taxes on Investment Income?

Children have their own income tax rate, and their own standard deduction. For 2010 (and presumably 2011), that standard deduction is $950. So, up to that point, the unearned income from investments doesn’t have to be reported, and isn’t taxed. However, above the standard deduction, your child is taxed at a 10% rate — until the earnings reach a certain threshold.

In 2009 and 2010, investment income above $1,900 was taxed at the highest tax rate for his or her parents. So, the 10% tax rate only applies for income between $950 and $1,900 (thresholds and standard deductions are likely to change in the future). Once your child’s investment income reaches the threshold, he or she must pay at your rate — which means that some of your child’s investment income might be taxed at 35%. That’s a pretty hefty tax for kids. (If your child has some earned income, consider holding some investments in a Roth IRA for your child.)

Who Is Considered a Child for Kiddie Tax Purposes?

If your child makes less than $1,900 in investment income, of course, the lower tax rate is to his or her advantage. Here are the age requirements the IRS lists for the Kiddie Tax:

  • Under age 18 at the end of the year
  • Age 18 at the end of the year, and doesn’t have earned income that amounts to more than half his or her support.
  • Full time student over 18 and under 24 whose earned income doesn’t amount to more than half the amount of his or her support.

A Form 8615 should be filed with the child’s tax return if the threshold of $1,900 is met and some of the income needs to be taxed at the parent rate. If you meet the right conditions, you might not have to file a tax return for your child. Instead, you would file a Form 8814 with your own tax return.

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Avoiding the Kiddie Tax

There are ways to avoid the Kiddie Tax by providing your child with investments that offer low interest, earnings and dividends through out the year. These investments will appreciate over time, and your child can sell the assets later, once he or she is no longer subject to the Kiddie Tax rules. Some of the options include U.S. savings bonds, municipal bonds, stocks, different mutual and index funds, and Treasury bills.

With the right planning, your child can prepare for the future with investments, without needing to pay the Kiddie Tax. Make sure your child holds on to some assets, avoiding selling them until the rules no longer apply. As long as you can keep earnings below $950 a year, there isn’t a tax to pay, and that can accomplished through buy and hold investing, bonds and cash products.

(Photo: lantzilla)

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