24.2 Children Subject to “Kiddie Tax” for 2012

The “kiddie tax” may subject a portion of your child’s investment income to tax at your tax rate, where your child’s tax rate is lower than yours. For 2012 tax returns, the kiddie tax applies if all of the following are true:

• Your child either (1) was under age 18 at the end of 2012, (2) was age 18 at the end of 2012 and did not have earned income exceeding half of his or her support for the year, or (3) was a full-time student during 2012 who at the end of the year was age 19 through 23 and did not have earned income exceeding half of his or her support for the year.

• Your child had more than $1,900 of investment income. The $1,900 floor is increased, as discussed below, if the child has itemized deductions exceeding $950 that are directly connected to the production of investment income.
• If married, your child filed separately from his or her spouse.

If both of a child’s parents were deceased at the end of 2012, the kiddie tax computation does not apply, and the child’s tax is figured under the regular rules.

Exceptions for children filing jointly and distributions from qualified disability trusts.

The kiddie tax does not apply to a child who is married and files a joint return for the tax year. The exception does not apply if the child is married filing separately.

If a child is a beneficiary of a qualified disability trust (see the Form 8615 instructions), distributions of investment income from the trust are treated as earned income and thus not subject to the kiddie tax rules.

Figuring kiddie tax on child’s or parent’s return.

The kiddie tax computation is generally made on Form 8615, which must be attached to your child’s return. However, if your child is under age 19 or a full-time student under age 24 and his or her only income is interest and dividends and other tests are met, you may elect on Form 8814 to include your child’s investment income on your own tax return, instead of computing the kiddie tax on Form 8615 (24.4).

Kiddie tax on Form 8615 applies to investment income exceeding $1,900 floor.

If your child files his or her own 2012 return, the “kiddie tax” computation on Form 8615 applies to the child’s net investment income. For purposes of this rule, net investment income equals gross investment income minus $1,900 if your child does not itemize deductions on Schedule A. Thus, if your child does not itemize, the first $1,900 of investment income is exempt from the kiddie tax. Investment income exceeding $1,900 is considered net investment income subject to the kiddie tax; see Example 1 in this section.

Investment income includes all taxable income that is not earned income (compensation for personal services). Include taxable interest income (but not tax-exempt interest), dividends, capital gain distributions and capital gains on the sale of property, royalties, rents, and taxable pension payments. Payments from a trust are generally included to the extent of distributable net income, but, as noted earlier, there is an exception for distributions from qualified disability trusts, which are treated as earned income and thus not subject to the kiddie tax. Income in custodial accounts is treated as the child’s income and is subject to the kiddie tax computation. Capital losses first offset capital gains, and any excess loss offsets up to $3,000 of other investment income.

Investment income on all of your child’s property must be considered, even if the property was a gift from you or someone else, or if the property was produced from your child’s wages, such as a bank account into which the wages were deposited. The wages themselves, or self-employment earnings, are not considered.

If your child does itemize deductions, and has more than $950 of deductions that are directly connected to the production of investment income, the $1,900 floor is increased. The floor is $950 plus the directly connected deductions. If the directly connected deductions are $950 or less, the regular $1,900 kiddie tax exemption applies, as in Example 2 below. Directly connected itemized deductions are expenses paid to produce or collect income or to manage, conserve, or maintain income-producing property. Only the part of the total expenses exceeding the 2% AGI floor may be deducted. These expenses include custodian fees and service charges, service fees to collect interest and dividends, and investment counsel fees. If, after you subtract the itemized deductions, your child’s net investment income exceeds his or her taxable income, you apply the kiddie tax to the lower taxable income, rather than to the net investment income.