Reporting a Child's Income on Child's
Return
If the election to include a child’s
unearned income on the parent’s return isn't, or can’t
be made, the child must file a separate return and compute the tax
liability at their parent’s highest marginal rate. This is done
by completing and attaching Form 8615, Tax for Certain Children
Who Have Unearned Income to the child’s return.
If
the child files a separate return, no personal exemption is allowed
if the child could have been claimed as a dependent on his or her
parents' return. However, the child can use up to $1,000 for 2014
($1,050 for 2015) of his or her standard deduction to offset unearned
income. Thus, only unearned income in excess of $2,000 in 2014 ($2,100
for 2015) is taxed at the parents' top marginal rate. These amounts
are indexed annually for inflation.
The parent’s tax information
is used to complete Form 8615. If the parent's taxable income, filing
status, or the net unearned income of the parent's other children
is not known by the due date of the child's return, you can use a
reasonable estimate and enter “Estimated” next to the
appropriate line(s) of Form 8615. But you will have to file Form 1040X, Amended
U.S. Individual Income Tax Return when the correct information
is available.
If the parents are married and file jointly, it
is clear what information to use for purposes of computing the kiddie
tax. However, if the parents are not married, then there are rules
to follow. If the parents were married but filed separate returns,
then the tax is computed using the parent who had the higher taxable
income. If the parents were unmarried, then use the tax information
on the parent’s return with whom the child lived for most of
the year (the custodial parent). You must do this regardless of whether
or not the custodial parent filed a joint return with his or her new
spouse, even if that person is not the child's parent. If the custodial
parent and his or her new spouse filed separate returns, then use
the person with the higher taxable income, again, even if that person
is not the child's parent. If the parents were unmarried but lived
together during the year with the child, then use the parent who had
the higher taxable income.
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Save Money The main downside of the under 24
provision is that college age students can no longer sell off their
appreciated investment accounts set up by the parents to cover current
tuition. At a minimum, taking out student loans with interest until
the year the student turns 24 will be necessary now to carry forward
such a plan. Although these tax rules can be an unexpected burden
for many families saving for college, 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 18
(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 ($2,100 for 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). For example, a cash gift to a 10-year-old child
of $9,000, earning interest at eight percent, could grow over $3,000
by the time the child reaches age 18, and each year's interest will
not exceed $1,300. Thereafter, the parent can set aside larger amounts
for the child and continue to achieve effective family income-splitting.
- 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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