The kiddie tax is a set of laws designed to stop parents from moving assets to their children to avoid paying taxes. It applies to unearned income — that is, income that doesn't come from working and being employed.
For example, your child may be the recipient of income from investments — dividends, interest and capital gains. Even rental property income can count as unearned if it is not operated as a full-time business. If that unearned income exceeds a certain minimal amount, it's taxed at the parent's tax rate instead of the child's tax rate, which would probably be much lower.
Under the kiddie tax, children pay tax at their own income tax rate on unearned income they receive, up to a threshold amount ($2,100 in 2017 and 2018). Once the unearned income rises above that amount, it's taxed at the parent's highest income tax rate.
It doesn't take much to trigger the kiddie tax. For example, a $50,000 investment generating 5 percent a year leads to an income of $2,500 — above the current threshold.
If the child actually earns money — anything from a paper route to starring in a Disney movie — it is not subject to the kiddie tax rules. That earned amount is subject to the child's rate.
The kiddie tax applies to:
The whole point of the kiddie tax is to prevent well-heeled parents from simply dumping highly taxed investment income into a child's account. But if you have a genuine interest in giving your children investment income, there are ways to benefit the children without hitting the limit.
Finally, there's the issue of how to file taxes for children with substantial unearned income. In many circumstances, the parents have a choice between adding the income to their returns or having the child file separately. There are advantages and disadvantages either way, and parents should consider the options carefully.
If your children have unearned income, give us a call and we can help you file and strategize for the future.
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