Wiley Tax Preparer: A Guide to Form 1040

CHAPTER 34

The Kiddie Tax

Tax on a child's investment income is figured in a special way. This tax is referred to as the kiddie tax. It is not a separate tax or an additional tax rate. It is merely a tax structure in place to eliminate the opportunity for parents to shift investment income to their child in a lower tax bracket. When the kiddie tax applies, the child's investment income (over a set amount) may be taxed at the parents' highest marginal tax rate.

The kiddie tax does not affect the way in which a child is taxed on his or her earned income from a job or self-employment. It only affects the tax on certain unearned income.

Under certain conditions, parents can elect to include the child's investment income on the parents' return and avoid the need to file a return for the child. This election may or may not be beneficial for the family.

General Rules of the Kiddie Tax

The kiddie tax applies to a child's investment income when all the following apply:

1. The child's investment income exceeds an inflation-adjusted threshold amount ($1,900 in 2012);

2. The child is:

a. Under age 18 at the end of the year, OR

b. Age 18 at the end of the year and did not have earned income that was more than half of the child's support, OR

c. A full-time student over the age of 18 and under age 24 at the end of the year and did not have earned income that was more than half the child's support;

3. The child is required to file a tax return for the tax year (see Chapter 1);

4. At least one ...