Kiddie Tax: The Only Goat Is Your Parents

Q: Tax Playa, my child has a pretty large portfolio in her name.  How do we pay taxes on that?
Susan, Fairfax VA

A: Children have to pay taxes just like adults do.  There are some special rules in place to limit the amount of tax advantages children can benefit from if their primary source of income is from investments (passive income)...

For more on this, please see IRS Publication 929, Tax Rules for Children and Dependents.

A child who is a dependent cannot claim their own personal exemption.  That goes to their parent or guardian who claims them as a dependent.

That normally leaves the standard deduction.  In 2008, the standard deduction for an individual is $5450.  A child's standard deduction, though, is the greater of:

• $900, or
• the child's earned income plus $300, but not more than the adult standard deduction of $5450

Even if the child doesn't have to file because their standard deduction is larger than their income, it is usually in his interest to because any income tax withheld will likely be refunded.

If a child's income from interest and dividends (including capital gains distributions) is less than $8000, the parents can elect to report this income on their own tax return (though this probably doesn't make much sense if they have a choice, since the child's marginal tax rate is likely to be lower).

If the child has investment income (all income besides wages and self-employment income) of more than $900, the amount of investment income over this amount is taxed at the parent's tax rate.  A child is defined as any dependent under the age of 18 (24 if the dependent-child is a full-time).  This is known as the "kiddie tax" and is designed to prevent high-asset parents from holding some wealth in their children's name and using the lower tax brackets to minimize taxes.

Comments

[paul]

Why can't a child with a large portfolio provide more than half of his own support and disqualify the parent from claiming him and then take his personal exemption on his own return and avoid the kiddie tax.