Explanation about the Kiddie Tax and Income Shifting Information

By | February 1, 2014

What is the Kiddie Tax?

There IRS is aware that some taxpayers may try to use a tax technique called income shifting. It seeks to take income out of your higher tax bracket and place it in the lower tax brackets of your children. This will not work most of the time due to special tax rules


Kiddie Tax Rules and Kiddie Tax Limitations

The “kiddie tax” rules impose substantial limitations on gifting assets to children to avoid taxes if:

  • the child hasn’t reached age 18 before the close of the tax year, or
  • the child’s earned income doesn’t exceed one-half of his support and the child is age 18 or is a full-time student age 19 to 23.

Explanation about the Kiddie Tax and Income Shifting Information

The kiddie tax rules apply to any children who are under the above cutoff ages, and who have more than a prescribed amount of unearned (investment) income for the tax year-$2,000 for 2013 and 2014. These kiddie tax rules will prevent income shifting from the parents and tax the children’s investment income at the parents higher rates. This allows the IRS to collect more taxes.


What Investments are not affected by Kiddie Tax?

The portion of investment income of a child that is taxed at the parents’ tax rates under the kiddie tax rules may be reduced or eliminated if the child’s investments produce little or no current taxable income. Such investments include:

  • securities and mutual funds oriented toward capital growth that produce little or no current income
  • vacant land expected to appreciate in value
  • stock in a closely-held family business, expected to become more valuable as the family business expands, but which pays little or no cash dividends
  • tax-exempt municipal bonds and bond funds
  • U.S. Series EE bonds


Avoiding the Kiddie Tax

Investments that produce no taxable income-and which are therefore not subject to the kiddie tax-also include tax-advantaged savings vehicles such as:

  • traditional and Roth individual retirement accounts (IRAs and Roth IRAs), which can be established and only contributed to if the child has earned income
  • qualified tuition programs (“529 plans”);
  • and Coverdell education savings accounts (“CESAs”).

Remember this important distinction that will affect child who have jobs earning income. A child’s earned income, which is different than investment income, is taxed at the child’s (not the parents’) tax rates, regardless of amount. Therefore, to save taxes within the family, consider employing the child and paying reasonable compensation. This is particularly appropriate if you have your own business.


Filing Kiddie Tax on Tax Returns

Where the kiddie tax applies, it is computed and reported on Form 8615, which is attached to the child’s Form 1040.

Parents can also elect to include their child’s income on their own tax return. This can be done if certain requirements are satisfied. This avoids the need for a separate return for the child, but, generally, doesn’t change the tax on the child’s unearned income, which is still taxed at the parents’ tax rate.

The election to include a child’s income on the parents’ return is made, and the additional taxes resulting to the parents are computed and reported, on Form 8814.


Summary of Kiddie Tax Rules

Children are taxed at the normally applicable rates on their earned income, and on their investment income (“unearned income”) up to a prescribed amount (which is adjusted annually for inflation—$2,100 in 2015). But under the “kiddie tax” rules, the investment income of children under age 19, and children age 19 to 23 who are full-time students, is taxed to the children, but at the rates that would apply if that income were included in the parents’ return, if that rate is higher than what the child would otherwise pay. However, as to a child age 18 or a child age 19 to 23 who is a full-time student, the kiddie tax rules apply only if the child’s earned income doesn’t exceed one-half of the amount of his support.