Your Child’s Investment Income and Taxes

Even young kids may have to pay tax on their investment income, depending on the amount they receive during the year. If their unearned income – interest, dividends, capital gains, and certain other types of income – was more than $1,100 in 2020, Uncle Sam expects a cut of it.

But how much of a cut? Assuming the child only has unearned income, the first $1,100 of it is generally not taxed thanks to a $1,100 standard deduction available to dependents. The next $1,100 is taxed at the child’s tax rate. And any amount over $2,200 is taxed at the parent’s tax rate. (2020 and 2021 amounts are used here.)

Taxing the amount of unearned income over $2,200 at the parents’ tax rate is known as the “kiddie tax” and is intended to limit the tax benefit that parents might receive by shifting their investments to their children simply to take advantage of the children’s lower tax rates.

The kiddie tax rules apply to the unearned income of children under the age of 18, as well as 18-year-olds and full-time students under the age 24 whose earned income is less than half of their support.

Will your child have to file a tax return? If the child’s unearned income is greater then $1,100, it generally must be reported on a tax return. Your child can file his or her own tax return, or you may be able to report the income on your own return. To report it on your return, your child’s gross income must be less than $11,000, it must consist only of interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends), and a few other conditions must be met.

Although reporting your child’s unearned income on your tax return may be more convenient, be sure to consider the impact that the additional income may have on your taxes. For example, an increase in your income may reduce the value of certain tax credits and deductions that have income limits.

It's a lot to consider and things get even more complex if your child has earned income from working, in addition to unearned income. And we’ve only scratched the surface of the kiddie tax rules here.

For help with navigating your child’s unearned income and taxes, please consult with us. With offices in Rutland and Williston, Vermont Copper Leaf Financial develops a customized wealth management plan designed to integrate every aspect of your financial life. Our approach is to provide clarity and calm amidst the chaos. Where there is uncertainty, we look for facts. We call our approach evidence-based investing. Call us today at 802-878-2731 to schedule a strategy session and begin building your road map to financial success.

Article published in March 2021 edition of Eye on Money. If you would like to be added to our mail list please email jennifer@dh-cpa.com.