Kiddie Tax Rules - Planning for Next Year

The term "kiddie tax" was introduced by the Tax Reform Act of 1986. The rules are intended to keep parents from shifting their investment income to their children to have it taxed at their child's lower tax rate. In 2014 the law requires a child's unearned income (generally dividends, interest, and capital gains) above $2,000 be taxed at their parent's tax rate.

Applies to:

  • Children under the age of 19
  • Full-time students under the age of 24 and providing less than half of their own financial support
  • Children with unearned income's above $2,000

How it Works:

  • The first $1,000 of unearned income is generally tax-free
  • The next $1,000 of unearned income is taxed at the child's (usually lower) tax rate
  • The excess over $2,000 is taxed at the parent's rate either on the parent's tax return (Form 8814) or on the child's tax return (Form 8615)

Planning thoughts

So while your child's unearned income above $2,000 is a problem, you will still want to leverage the tax advantage up to this amount. Here are some ideas:

  • Maximize your lower tax investment options. Look for gains in your child's investment accounts to maximize the use of your child's kiddie tax threshold each year. You could consider selling stocks to capture your child's investment gains and then buy the stock back later to establish a higher cost basis.
  • Be careful where you report a child's unearned income. Don't automatically add your child's unearned income to your tax return. It might inadvertently raise your taxes in surprising ways by exposing more income to the Alternative Minimum Tax or reducing your tax benefits in other programs like the American Opportunity Credit.
  • Leverage gifts. If your children are not maximizing tax-free investment income each year consider gifting funds to allow for unearned income up to the kiddie tax thresholds. Just be careful, as these assets can have an impact on a child's financial aid when approaching college age years.

Properly managed, the "kiddie tax" rules can be used to your advantage. But if not properly managed, this part of the tax code can create an unwelcome surprise at tax time.

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