The kiddie tax law was enacted in 1986. It was created to treat issues relating to unearned income tax for 18 years or below people. The scheme was also made available for dependent students below 24 years old.
The kiddie tax concept is necessary for parents of growing investors or parents of a student with an investment portfolio to understand. This tax law was made for a child's unearned income above $2,200. This income can be generated from working and other alternate sources. It could be from an investment income, taxable scholarship, and inherited IRAs.
The tax works like this:
Standard deduction covers the first $1,100 such that it will not be taxed. The following payment is taxed at a marginal tax rate for a child. An unearned income of above $2,200 is taxed at the parent's marginal tax rate.
How The Kiddie Tax Works?
As stated above, the kiddie tax is available to children or full-time students between 18 and 23, respectively. An exception to this law is wages, salary, and a child that has earned income that is more than half their support fund. Only unearned income applies to the tax rule.
Children referred to as dependent in this article refer to anyone who is not eligible to fill their tax return themself. The rule applies to the following dependents - children who did not earn more than half of their support, children below 18, and full-time college students between 19 and 23 with income less than half of their support.
Funds generated from a business or W-2 jobs generally are titled earned income.
Unearned income is limited to:
A child’s taxable interest
The capital gains from investments
Dividends from shares
Taxable scholarships
Revenue generated from custodial accounts
Revenue generated from gifts from the grandparents
Rental income
How To Apply For The Kiddie Tax
If you could accumulate $2,300 as a child in unearned income, your parents might want you to be a dependent. A dependent’s income is filed in Form 8615. Every tax filing software supports this form.
Making $2,300 annually is pleasant for a budding investor. You will be saved some money if you file your return. If your unearned income is over $11,000, your file will be filled in a separate return.
Depending on some factors, some dependents will prefer when their parents claim they are dependent and use Form 8615. Parents whose child has made over $2,300 will also fill Form 8615.
When you are stuck on which option suits your situation best, utilize your tax software.
Children under 14 are not legally allowed to work; therefore, the tax law only covered them before the change was implemented. Upon discovering how guardians took advantage of the situation, the law was later imposed on teenagers who were 18 years old. Children who had an unearned income higher than a yearly threshold were considered eligible for kiddie tax law.
Unearned income exceeding the yearly determined threshold was taxed at the parent’s rate. A law was passed to change it to a child's rate rather than parents temporarily'. It was changed in a later year to the parent's rate.
Conclusion
Before the advent of the kiddie tax, parents placed investment accounts using their child’s name to save taxes. Income obtained from stocks and assets gifted by their parents is taxed at the low-income rate of a child. The kiddie tax law taxed the income at higher rates.
Some wealthy parents took advantage of the lower tax rate by transferring assets to their children. This was why the kiddie tax law came into existence.
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