Monday, June 8, 2015

The Trouble with Children (part 2 of 3): I have to pay tax on what?!

(This is Part 2 of a 3-part series of related blogs. Part 1 discussed various tax credits for children and child care expenses.  Part 3 will discuss the credits available for higher education expenses for college students.)

There are important tax issues to consider if your child has earned income, like from an after school or summer job for example, or investment (unearned) income such as interest and dividends. Generally, if a child has earned income in excess of the standard deduction ($6,300 for 2015), unearned income over $1,050, total income exceeding the larger of $1,050 or the standard deduction for that year, or self-employment income of $400 or more, they must file their own return. If any tax has been withheld from their income, whether earned or unearned, they must file a return to get a refund of the tax withheld.

Tax on a child’s income is computed as for any other taxpayer, with limits on the personal exemption (because they are claimed as a dependent by someone else), and a lower standard deduction. Some children with investment income may be taxed on this income at their parents' highest marginal tax rate. This is known as the “kiddie tax”, and applies if the child is required to file a tax return, does not file a joint return for the year, and has investment income of more than $2,100 (for 2015). The child must also be under 18, under 19 and not provide more than half their support from earned income, or under 24, a full-time student, and not provide more than half their support from earned income.

If a child has only unearned income from interest and dividends, the parent may elect to include the child’s income on the parent’s return to avoid the kiddie tax. The election is made on Form 8814 and the child must meet the following requirements:

  • Is required to file a return and would be subject to the kiddie tax
  • Only has income from interest and dividends
  • Income is more than $1,050 and less than $10,500
  • Made no estimated tax payments, including overpayments from the prior year, and
  • Is not subject to backup withholding

The parents are then taxed on the child’s income in excess of $2,100, plus an additional tax of $105 if the child’s taxable income is more than $1,050, or 10% of taxable income under $1,050.

In short, if your child has earned or unearned income, you should consult your tax advisor to determine your filing requirements and limitations.  

Melissa Gregg