Kiddie Tax Update

In the good old days, highly taxed parents could shelter some of their investment income by attributing it to their lower taxed older children. No more. The kiddie tax captures that income at the parent’s rate. Parents may not realize there are tax rules that could affect their child’s investment income. Here’s how it works. A child is subject to the kiddie tax if:

  • He or she has not attained age 18 as of the close of the tax year; or has earned income that does not exceed half of his or her support and is either age 18 or a full-time student age 19–23;
  • Either parent of the child is alive at the end of the tax year; and
  • The child does not file a joint return for the tax year.

Note: The kiddie tax applies to children under age 18 regardless of their earned income level.

A child subject to the kiddie tax pays tax at his or her parents’ highest marginal rate on the child’s unearned income over $1,900 (for 2012) if that tax is higher than the tax the child would otherwise pay on it. The parents can instead elect to include on their own return the child’s gross income in excess of $1,900 (for 2012).

An individual eligible to be claimed as a dependent on another taxpayer’s return may not claim a personal exemption. Thus, a child cannot claim a personal exemption ($3,800 in 2012) if his or her parents can claim an exemption for him or her; whether they actually claim the exemption is irrelevant.

The 2012 standard deduction for a child claimed (or eligible to be claimed) as a dependent on another return is the greater of $950 or the sum of $300 plus earned income, but not to exceed the $5,950 (for 2012) standard deduction that would otherwise be allowable. For 2012, a child with no earned income (e.g., wages) may use a standard deduction to avoid tax on the first $950 of unearned income (e.g., dividends); the next $950 is taxed at the child’s tax rate. Therefore, in 2012, the kiddie tax provision does not affect the child until unearned income exceeds $1,900 (or greater if the child itemizes deductions and deductible expenses directly connected to the unearned income exceed $950).

Example: Child with earned income.

Johnny, age 17, earns $2,000 delivering newspapers. He also had $1,300 of dividend income, for a total of $3,300. The earned income from the paper route ($2,000) is fully sheltered from tax by Johnny’s standard deduction of $2,300 ($2,000 earned income plus $300; limited to $5,950 in 2012). So, the $1,000 excess ($3,300 – $2,300) will be taxed at a normal 10% tax rate. The kiddie tax does not apply because unearned income is less than $1,900.

 

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