Chapter 24
Computing the “Kiddie Tax” on Your Child’s Investment Income

If the “kiddie tax” applies to your child, your child’s 2017 investment income in excess of $2,100 is taxed at your tax rate. The kiddie tax applies not only to children under age 18, but also to children who are age 18 or full-time students age 19–23 who do not have earned income exceeding half of their support. Only investment income of a child over $2,100 is subject to the kiddie tax, not wages or self-employment earnings.

The kiddie tax is generally figured on Form 8615 as part of the computation of the child’s regular tax liability for the year. The liability from Form 8615 is then entered on the child’s own tax return, and Form 8615 is attached. The Form 8615 computation has no effect on the treatment of items on your own return or on your tax computation. Instead of completing Form 8615, you may elect on Form 8814 to report the child’s investment income on your own return, provided the child received only interest and dividend income. If you elect on Form 8814 to report the child’s investment income on your own return, your adjusted gross income will increase and this could adversely affect your right to claim various deductions and tax credits and even subject you to the additional 3.8% tax on net investment income (24.4).

If you are married but file separately, the parent with the larger amount of taxable income is responsible for the kiddie tax computation. If parents are divorced, separated, unmarried, or living apart for the last six months of the year, the parent who has custody of the child for the greater part of 2017 computes the tax. If a child cannot get tax information directly from a parent, the legal representative of the child may ask the IRS for the necessary information.

24.1 Filing Your Child’s Return

To discourage substantial income splitting of investment income between parents and minor children, the tax law has complicated income reporting for parents and children by—

1. Imposing a “kiddie tax” that taxes a child’s investment income over an annual floor ($2,100 for 2017) at the parent’s tax bracket. The kiddie tax applies not only to children under age 18, but also to most 18-year-olds and students under age 24 (24.2).
2. Barring a dependent child (21.1) from claiming a personal exemption on his or her own tax return.
3. Limiting the standard deduction for a dependent child who has only investment income. For 2017 the deduction is $1,050 (13.5).

Does your child have to file? For a child who can be claimed as a dependent either as a qualifying child or a qualifying relative (21.1), the income filing threshold for 2017 is generally $1,050. If your dependent child has gross income (earned and investment income) of $1,050 or less for 2017, he or she is not subject to tax and does not have to file a tax return.

A 2017 return must be filed for a dependent child with investment income exceeding $350 and gross income of more than $1,050. If a dependent child has salary or other earned income but no investment income, a return does not have to be filed unless such earned income exceeds $6,350 for 2017. If your child’s only income is from interest and dividends, you may be able to make an election to report the income on your own return, but this generally is not advisable (24.4).

Although a dependent child may not claim a personal exemption on his or her 2017 tax return, the child is allowed to claim at least a $1,050 standard deduction. A dependent child with earned income over $1,050 may claim a standard deduction up to those earnings plus an additional $350, but no more than the basic standard deduction, which is generally $6,350 (13.1).

How to file a 2017 return for your child. If your child is not subject to the “kiddie tax” under the rules at 24.2, follow the regular filing rules and use Form 1040EZ, 1040A, or Form 1040 to report the child’s income and deductions. Since the “kiddie tax” computation does not apply, all of the child’s income will be taxed at his or her own tax rate. If your child is unable to sign his or her tax return, you must do so (1.13).

If the kiddie tax computation applies (24.2), Form 8615 must be filed to compute the kiddie tax unless your child’s only income is interest and dividends and you elect to report your child’s investment earnings on your own return (24.4). On Form 8615 you must provide your Social Security number and taxable income. Form 8615 is attached to the child’s tax return (24.3).

Child’s AMT liability. A child who has substantial tax-exempt interest, tax preferences, or tax adjustments subject to the alternative minimum tax must compute tentative AMT liability on Form 6251; see Chapter 23.

24.2 Children Subject to “Kiddie Tax” for 2017

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 2017 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 2017, (2) was age 18 at the end of 2017 and did not have earned income exceeding half of his or her support for the year, or (3) was a full-time student during 2017 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.

  For children born on January 1, the IRS treats the child’s birthday as being on the last day of the prior year. Thus, a child who attains age 24 on January 1, 2018, is considered to be age 24, not 23, on December 31, 2017, and so the kiddie tax does not apply to the child’s 2017 investment income under test (3) above for full-time students.

  For purposes of determining if the kiddie tax applies under tests (2) or (3) above, use the dependency exemption rules for full-time student status (21.3) and support (21.5).

• Your child had more than $2,100 of investment income for 2017. The $2,100 floor is increased, as discussed below, if the child has itemized deductions exceeding $1,050 that are directly connected to the production of investment income.
• If married, your child files a separate 2017 return from his or her spouse.

If both of a child’s parents were deceased at the end of 2017, the kiddie tax computation does not apply regardless of the above tests, and the child’s tax is figured under the regular rules.

Exceptions for children filing jointly and distributions from qualified disability trusts. A married child can be subject to the kiddie tax only if he or she files separately; kiddie tax does not apply if a joint return is filed.

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 $2,100 floor. If your child files his or her own 2017 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 $2,100 if your child does not itemize deductions on Schedule A. Thus, if your child does not itemize, the first $2,100 of investment income is exempt from the kiddie tax. Investment income exceeding $2,100 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 $1,050 of deductions that are directly connected to the production of investment income, the $2,100 floor is increased. The floor is $1,050 plus the directly connected deductions. If the directly connected deductions are $1,050 or less, the regular $2,100 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% of 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.

24.3 Computing “Kiddie Tax” on Child’s Return

If your child is subject to the “kiddie tax” (24.2) for 2017, your child’s regular income tax liability is computed on Form 8615, which is attached to his or her return, unless you make the parent’s election to report the child’s dividends and interest income on your own return (24.4). Before your child’s Form 8615 can be completed, your own taxable income and regular income tax must be determined. When you make the computation on Form 8615 for your child, you add your taxable income to your child’s net investment income in excess of $2,100. You figure the tax on the combined amount based on your filing status, using the Qualified Dividends and Capital Gain Tax Worksheet (or, if applicable, the Schedule D Tax Worksheet) if the combined amount includes net capital gain or qualified dividends (5.3). The excess of the resulting tax over your own separately figured tax liability is generally the kiddie tax on the child’s investment income exceeding $2,100. That tax, plus the tax on the portion of the child’s taxable income not subject to the kiddie tax, is reported as the child’s regular tax liability on his or her Form 1040 or 1040A.

The kiddie tax computation on Form 8615 does not affect your tax liability or the way you compute any limitation on deductions or credits on your own return. For example, the addition of your taxable income to your child’s net investment income is simply a step in figuring the kiddie tax due on the child’s Form 8615 and does not affect your adjusted gross
income for purposes of applying the AGI limits for deductible IRA contributions, medical expenses, or miscellaneous expenses on your tax return. Since the investment income is your child’s, not yours, it is not subject on your return to the additional 3.8% Medicare tax on net investment income (28.3).

Which parent’s return to use. If the parents file a joint return, their joint taxable income is entered on Form 8615, along with the net investment income (24.2) of all their children subject to the kiddie tax. If the parents file separate returns, the larger of the parents’ separate taxable incomes is used on the child’s Form 8615.

Where parents are legally separated or divorced and custody of the child is shared, Form 8615 should be completed using the taxable income of the parent who has custody for the greater part of the year. If parents are married but living apart, and the custodial parent qualifies as unmarried under the Head of Household rules (Test 1, 1.12), the custodial parent’s taxable income is used on Form 8615. If the custodial parent is not considered unmarried, the income of the parent with the larger taxable income is used. If the custodial parent has remarried and files a joint return with a new spouse, their joint return taxable income is used on the child’s Form 8615. If the parents were never married but they live together with the child, the income of the parent with the larger taxable income is used; if the parents live apart, the income of the parent with custody for most of the year is used on Form 8615.

More than one child subject to kiddie tax. You file a separate Form 8615 for each child and on each form net investment income of all the children subject to the tax is included. The computed tax is allocated to each of your children, according to his or her share of their combined net investment income. This computation is incorporated in the steps of Form 8615 and by following the order of the form, you will make the proper allocation.

Estimating the kiddie tax in case of filing delay. If you are unable to file your 2017 return by the filing due date of April 18, 2017, the child’s tax on a timely filed Form 8615 may be based on an estimate. You may make a reasonable estimate of your taxable income on Form 8615 or may estimate the net investment income of children under age 18 if that information is not yet available. When you have the complete income details, file an amended return for the child on Form 1040X.

A reasonable estimate may be based on your 2016 taxable income and the 2016 investment income of the child. If a refund is due on the amended return, the IRS will pay interest from the filing due date (April 17, 2018), or, if the return was filed late, from the filing date. If additional tax is due on the amended return, interest will be charged from the filing due date, but no penalty will be imposed.

Instead of estimating the kiddie tax, you may file Form 4868 to get a six-month extension (46.3) for the child’s return on which the kiddie tax is included. However, interest will be charged on any tax due that was not paid by the original filing date, and late payment penalties may also apply (46.3).

24.4 Parent’s Election To Report Child’s Dividends and Interest

Instead of filing a separate return for your child (24.3) whose income is subject to the “kiddie tax,” you may elect on Form 8814 to report your child’s income and compute the kiddie tax on your own 2017 return if all of the following tests are met:

• The child was under age 19, or under age 24 if a full-time student (24.2) at the end of 2017;
• The child’s only 2017 income is from interest and dividends (including mutual fund capital gain distributions and Alaska Permanent Fund dividends);
• The total interest and dividends are over $1,050 but less than $10,500;
• Estimated tax payments were not made in the child’s name and Social Security number for 2017 and there was no overpayment from the child’s 2016 return applied to his or her 2017 estimated tax; and
• The child was not subject to 2017 backup withholding.

On Form 8814, you determine the portion of the child’s qualified dividends and capital gain distributions that you report on your own return, where they are eligible for the preferential rates (5.3) for qualified dividends/net capital gains. You report the balance of the child’s investment income over $2,100 as “other income” on Line 21 of your Form 1040. You also figure an additional tax equal to the smaller of $105 or 10% of your child’s income over $1,050, which is included in the regular income tax liability you enter on Line 44 of your Form 1040. If you use Form 8814, you cannot file Form 1040A or Form 1040EZ.

If the parents are married filing separately, or are divorced, separated, unmarried, or living apart for the last six months of the year, the parent whose taxable income would be taken into account on Form 8615 (24.3) is the parent who may elect to report the income on his or her own return.

The election can have major disadvantages. For most taxpayers, the only advantage in making the election is to skip the paperwork involved in preparing a return in the child’s name or returns in the children’s names. This could save you money in the form of reduced tax preparation costs. In some cases,the increase in your income could allow you to deduct more charitable contributions (14.17). Reporting your child’s interest or dividends increases your net investment income, which may allow you to claim a larger deduction for investment interest (15.10), but if you are close to or already over the threshold for the additional 3.8% tax on net investment income (28.3), making the election could subject you to or increase your liability for the 3.8% tax.

There is a distinct disadvantage to the election if your child’s investment income consists of qualified dividends or capital gain distributions. With the election, there is a 10% tax on the child’s income between $1,050 and $2,100 (the income not subject to kiddie tax), whereas if a separate return is filed for the child, it is highly likely that the qualified dividends and capital gain distributions will escape tax entirely under the zero percent rate (5.3).

If you elect to report the child’s income on your own return, you may not claim any deductions that your child would have been able to claim on his or her own return such as the additional standard deduction for blindness, itemized deductions such as charitable donations or investment expenses, or the above-the-line deduction for the penalty on premature withdrawals from a savings account.

Finally, including the child’s investment income as your own may create these disadvantages by increasing your AGI:

• Make it more difficult to deduct job expenses and other miscellaneous itemized deductions, which are subject to a 2% of AGI floor (19.1), and medical deductions, subject to the AGI floor (17.1).
• Reduce tax credits subject to income limits, such as the child tax credit (25.2), the dependent care credit (25.5), or the education tax credits (33.7).
• Limit a deduction for IRA contributions under the phaseout rules (8.4).
• Limit a deduction for student loan interest (33.13).
• Limit your ability to claim the special $25,000 rental loss allowance under the passive activity rules (10.2).
• Increase local and state tax liability.
• As noted earlier, subject you to or increase your liability for the additional 3.8% tax on net investment income (28.3).
• Increase alternative minimum tax. In figuring whether you owe alternative minimum tax (AMT) on Form 6251, you must include, as a tax preference item, interest income your child receives from specified private activity bonds (23.3); see the Form 6251 instructions.
• Subject you to an estimated tax penalty (27.1). If you did not account for the child’s income when planning your 2017 withholdings or estimated tax installments, you could face an estimated tax penalty if you make the election on Form 8814 for 2017. If you plan to report your child’s income on your 2018 return, provide for the tax in your estimated tax payments or withholdings during 2018.