A child's unearned income is subject to a special rule known as the "kiddie tax." The kiddie tax originated as an attempt to keep parents from reducing their tax bill by putting money-making investments in the names of their children, who usually are subject to lower income tax rates. Under the kiddie tax, as of 2011, the first $950 of a child's unearned income is tax-free, the next $950 is taxed at the child's normal tax rate, and everything above $1,900 is taxed at the parents' income tax rate. All unearned income of a dependent child is subject to the kiddie tax rule until the child turns 19 years old, or 24 if the child is a full-time student.
It's common for dependent children to receive income from investments held in their name or savings accounts set up on their behalf. Because such money doesn't come from work, the tax code considers it "unearned." How parents report a child's unearned income depends on how much there is, whether the child also has earned income and what kinds of unearned income are included in the total.
The first step in reporting a child's unearned income is to determine whether the child needs to file an income tax return. If the child had only unearned income for the year, and that income was less than $950, then no return is required, and no tax is due. If the child had only unearned income, but it was more than $950, the child must file a return. If the child had both earned and unearned income, then the child must file a return if any of these three conditions apply: Unearned income was more than $950; earned income was more than $5,700; or the child's total income, earned and unearned, was more than the greater of these two figures: $950, or the earned income plus $300.
If a child has unearned income and is required to file a tax return, then the child -- or, more likely, the child's parents -- must fill out IRS Form 8615. This form calculates the effect of the kiddie tax on the child's unearned income and determines how much the child owes. Even if the child's unearned income doesn't exceed $1,900, meaning that none of it is subject to the parents' tax rate, this form must still be attached to the child's tax return.
Reporting Income on Parents' Return
If a dependent child has only unearned income, and that unearned income comes only from interest and dividends -- rather than capital gains, rent or other unearned sources -- then the parents have the option of reporting the income on their own return, in which case the child does not have to file a separate return at all. Parents who choose to do this must fill out Form 8814 and attach it to their own return. This form tells the parents how much of the child's income to report and where to report it on their return, as well as how much tax applies. This form takes into account the fact that the first $1,900 of the child's unearned income is not subject to the parents' rate. Parents with more than one child with such income may fill out a separate Form 8814 for each child.
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