Reporting a Child's Income on Your Tax Return

There are two options to reporting and paying the “kiddie tax.” You can file a separate return for your child and compute his or her tax at your top marginal rate, or you may, under some circumstances, elect to report your child’s unearned income on your return. If you report your child’s income on your return, your child will not have to file a return.

However, to include your child's unearned income on your return, all of the following must be true:

• the child was under age 19 (or under age 24, if a full-time student) at the end of the year,
• the child's income consists entirely of interest and dividends, including capital gain distributions and Alaska Permanent Fund dividends,
• the child's gross income was less than $10,000 for 2014 (less than $10,500 for 2015),
• no estimated tax payments were made in the name of the child, including prior year overpayments, and
• the child had no federal tax withholding

The election must be made by the due date (including extensions) of the regular tax return by attaching Form 8814, Parent's Election to Report Child's Interest and Dividends.

You qualify to make this election if you file Form 1040 or Form 1040NR and any of the following apply.

• You file a joint return with the child’s other parent.
• You were married to the child’s other parent but file separate returns and you had the higher taxable income.
• You were unmarried, or separated from the child’s other parent and the child lived with you for most of the year (you were the custodial parent). If you were the custodial parent and you remarried, you can make the election on a joint return with your new spouse. But if you and your new spouse do not file a joint return, you must have higher taxable income than your new spouse to make the election.

Note. If you and the child’s other parent were not married but lived together during the year with the child, you qualify to make the election only if you are the parent with the higher taxable income.

One disadvantage to making this election instead of filing a separate tax return for the child, is that you may pay up to $100 more tax. This is because the tax rate on the child’s income between $1,000 and $2,000 is 10% if you make this election. However, if you file a separate return for the child, the tax rate may be as low as zero percent because of the preferential tax rates for qualified dividends and capital gain distributions.

Another thing to consider is that the child’s income reported on your return is included for purposes of computing your net investment income tax.

Also, on the negative side, including the child's income could result in a reduction in your deduction for medical expenses, IRA contributions and casualty losses which are subject to a percentage of adjusted gross income. In addition, the income may increase family state income taxes that otherwise would not be payable absent the election.

However, by including the child’s income on your return you get to claim the dependency exemption. If the child files their own return, the exemption is lost.

One situation in which the election might produce significant tax savings is where the parent is, for example, in a high tax bracket and cannot deduct investment interest because he or she does not have enough investment income. The election should enable the parent to treat the child's income as the parent's own investment income so that the parent would be able to make use of the interest deduction. Charitable contribution deductions also may be increased.

Another benefit would be relief from having to file the complicated "kiddie tax" form that is attached to the child’s tax return (Form 8615, Tax for Certain Children Who Have Unearned Income), especially where more than one child is involved.

Save Money The "kiddie" tax rules can be an unexpected burden for many families saving for college. However, the following gift-giving strategies can help reduce or even eliminate the kiddie tax and cut the overall family tax bill: Buy Series EE bonds for the child and have the child elect to defer tax on the interest as it accrues. Invest the child's money in securities with low yields but strong appreciation potential. If the securities are retained until age 19 (or age 24, if a full-time student), appreciation during the child's younger years escapes the kiddie tax. Invest in raw land with appreciation potential. From the tax viewpoint, the land should be held until the child reaches age 19 (or age 24, if a full-time student) Buy cash-value life insurance. Inside build-up from the policy will accumulate tax-free. If the child is a beneficiary of a trust, coordinate trust income with income from outside of the trust. Although this is a less attractive option, one can still accumulate trust income up to the amount taxed to the trust at the 15 percent rate ($2,450 for tax years beginning in 2014 ($2,500 for 2015)). Place UGMA and Uniform Transfers to Minors Act (UTMA) funds in tax-exempt bonds until the child reaches age 19 (or age 24, if a full-time student). Tax-exempt zero coupon bonds may be a particularly good way to avoid the kiddie tax and build a college fund. Another approach is to buy stripped municipal bonds. Buy market discount bonds for the child, keeping the current yield below $2,000 in 2014 (and $2,100 in 2015) so that the kiddie tax will not apply. When the bond is redeemed (or sold) after the child reaches age 19 (or age 24, if a full-time student), the built-in discount will be taxed at the child's rates. Set up a gift-giving program that keeps the child's unearned income below the threshold until he or she reaches age 19 (or age 24, if a full-time student). Employ the child in the family business or in the performance of chores supporting the payment of earned income. The income can be sheltered by the standard deduction. Even a young child can perform compensable services.

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