Avoid “Kiddie Tax”

kiddie taxThe “kiddie tax” is a special tax intended to stop you from shifting investment income to children, who are presumably taxed at lower rates than their parent(s). For 2017, the tax applies to dependent children under age 19 and dependent full-time students under age 24 who report unearned income over $2,100. Here are the rules:


  • If your dependent child’s unearned (investment) income is under $1,050, no return is needed.


  • If your child’s unearned income is more than $1,050, a return is required. Unearned income from $1,050 to $2,100 is taxed at the child’s rate.


  • If your child’s unearned income exceeds $2,100, the kiddie tax kicks in. (If your child itemizes deductions and has more than $1,050 in deductible investment expenses, the floor is $1,050 plus the deductible investment expenses.)


  • The actual kiddie tax due is the increase in your total tax that results from adding the amount of your child’s income subject to the tax to your own income.


  • If you’re married filing separately, use the larger separate taxable income to calculate the kiddie tax.


  • If you’re divorced, use the income of the parent who has custody for the greatest part of the year to calculate the tax.


  • Your child’s income doesn’t increase your AGI for purposes of figuring limits on deductions or credits. For example, it won’t keep you from contributing to a Roth IRA.


  • If your child’s income is $10,000 or less and derives solely from interest and dividends, you can report it on your own return using Form 8814. You’ll pay your child’s regular tax plus whatever kiddie tax is due. This avoids filing a separate return for your child. However, this does increase your AGI for purposes of figuring limits on deductions or credits.


  • The kiddie tax rules crimp your ability to cut tax by shifting investment income to your children. But you can still save tax by shifting investment income up to the kiddie tax threshold into your child’s name. And the new special dividend rates narrow the difference between your tax and theirs. You can also invest your child’s assets in vehicles that don’t generate current income:


  • U.S. Savings Bonds that mature after the child is no longer subject to the tax.
  • Municipal bonds
  • Education IRAs
  • Section 529 plans
  • Rental real estate, oil & gas, or equipment leasing programs using depreciation deductions to shelter income.