When it comes to filing taxes with children, there’s a lot of information to cover. The changes over time have made it difficult for many people to keep up. There’s one tax that’s been in place for quite some time, originally established under the Tax Reform Act of 1986: the Kiddie Tax.
This tax has a unique role in protecting people from evading taxes. Before this was in place, parents could easily save on tax rates by setting up investments in their children’s names. The parents would gift stocks, income, and other assets, and the income from that would be taxed at the lower rate for a child instead of the higher adult rate. Implementing the Kiddie Tax took care of closing this loophole for good.
The Kiddie Tax is the part of the reform act that states that children’s passive income should be taxed at higher rates, using a tax bracket that includes rates based on the level of income. This tax applies to dependent children under age 19, as well as full-time students aged 19 to 23. Children whose earned income is more than half the cost of the support they receive are excepted from this rule, as are children who are married and file joint tax returns.
What Can Be Taxed?
Wages, salary and tips, and even self-employment earnings cannot be held subject to this specific tax. Unearned income specifically refers to things like:
- Taxable scholarships
- Dividends
- Taxable interest
- Capital gains
- Income product by custodial accounts (according to the UGMA, Uniform Gifts to Minors Act)
- Income produced by gifts from grandparents
So, if grandma and grandpa want to gift your child some cash for their future, make sure that you declare it properly so that it’s effectively taxed and you don’t end up owing money in the end.
How Does the Tax Work?
The basic structure of the law remains the same, but the parameters and dollar amounts will change from time to time with the Kiddie Tax law. For 2022, the first $1,100 of unearned income is untaxed. The next $1,110 is subject to the child tax rate, and anything over $2,200 is taxed at the parent’s marginal rate. This will be easily figured out when you file IRS Form 8615, which is required for the Kiddie Tax. Any child that has an unearned income of more than $11,000 needs to file a separate tax return.
It’s also important to note that interest from 529 savings plans and other related college accounts aren’t subject to this tax. All contributions to these accounts already come from post-tax dollars and the interest grows at a tax-deferred rate. And, distributions are tax-free if the funds are used for higher education costs that qualify.
Ultimately, it’s a good idea to consult a professional when you’ve got any kind of complexity to your income taxes, including things like filing the Kiddie Tax for your children’s unearned income. With the right people on your side, you’ll make sure the right taxes are paid.
