Kiddie Tax and Children’s Tax Returns

Since nothing new and contentious has appeared in the Federal or Colorado tax world in the past few days, I figured it’s time to tackle an actual tax topics.

Weird, I know. And just a bit boring. But since people have to file their taxes, and since they’re still using Google for tax advice (including tax accountants), I figured I might as well get a few hits.

Today’s topic of the day is Children. Specifically, after all that time of wanting your kids to finally contribute to the family finances instead of being a constant drain on the pocketbook (not to mention a terror with the mustard), what are you supposed to do with the money they earn to keep to keep Uncle Sam from hauling you away?

And yes, if your child doesn’t pay taxes, the government will consider that on you.

Like everything in the tax world, there’s more twists and turns than a Russian ballet, so I’ll stick with some of the more common items I’ve seen.

Note that for all of these situations, we’re assuming that your Little Superhero is still claimable as a dependent on your tax return.

How to Handle Unearned Income

Let’s say either you or some grandparent set up an investment account for your child. This can be done in all sorts of ways, but let’s skip past that part and go directly to the day that you receive a 1099 from Morgan Stanley with your Precious Pea’s name on it. What do you do?

This statement will include dividends and/or interest, and this kind of income is known as “Unearned Income,” which in this case means income that comes from making your money work rather than your work. If this is the only income your child receives, you may be subject to the Kiddie Tax.

So here’s the deal. If your Pumpkin earned more than $2,100 in this Unearned Income stuff, you’re gonna have to pick up the tax tab on your your return. Which means that even though your Tiny Monster would be in a low tax bracket with his or her own, it’ll be taxed at your tax bracket. Which  sucks, especially if you’re in one of those high brackets. This would be done by filling out Form 8615.

Alternatively, you can file an election to include that Unearned Income as part of your income (assuming the Unearned Income is between $1,050 and 10,500 in 2015 or 2016), which is done using Form 8814. This gets you to about the same point, but instead of being called The Kiddie Tax, it’s called. . .well, just Tax.

Which method is better? For most people, you’ll come to the same place either way. Form 8814 is easier to fill out, though, which has to count for something.

Anything to make life easier when you have kids is a plus in my book

Almost anything to make life easier when you have kids is a plus in my book

How to Handle Earned Income

What if Your Little Terror finally get off his or her butt to work a real job? You might have another tax return filing on your hands.

When it comes to your kid’s tax return, similar rules apply as for yours. That means if your child won’t owe any taxes, no tax return is required. You can still file one if taxes were withheld on the W-2 and your Exasperating Teen wants that money back, which I totally understand.

The rules are slightly different for a dependent. He or she can take the standard deduction, but it’s limited to the greater of $1,050 or the sum of $350 plus earned income, but not in excess of the standard deduction amount for single individuals ($6,300 in 2016). Plus he or she won’t get a Personal Exemption, since you get theirs on your return.

Let me explain that one a bit better with some examples, since I had to think through it several times to get it down:

Example 1: Sadhbh (I’m trying to make that name popular in the US) is 16 years old and can be claimed as a dependent on her parents’ tax return. She makes $1,000 flipping burgers at McDonalds ($400 was withheld in taxes). She does not need to file a return, since she made less than the standard deduction amount, but she wants that $400 back.

When she files, she’s able to take a standard deduction of $1,350 (Earned Income Plus $350). So her Taxable Income for the year would be -$350, and she’d get the full $400 withheld back.

What about that extra $350 deduction? What good does that do? Well, nothing in this case, but let’s move onto. . .

Example 2: Sadhbh is in the same situation, with $1,000 at McDonalds and $400 withheld. HOWEVER, she also hsd $2,200 in dividend income from an investment her Grandma gave to her. How Now Brown Cow?

When she files her return, she’d still get the same deduction of $1,350. But since her total income is $3,200, she’ll still have $1,650 of taxable income thanks to Grandma’s gift.

Note that Sadhbh does NOT have to file in this case, but if she doesn’t file, that $2,200 of Unearned Income would have to be picked up on her parents return, which may or may not have a worse tax effect.

What About Social Security Benefits?

Several times this year, I’ve seen children receiving Social Security payments because they had a parent pass away in prior years. How would this be taxed?

While the Social Security income is considered Unearned Income, it has its own crazy stuff going on. You’d want to take a look at the Social Security Tax rules, which will most likely make the total income not taxable. If your child does have enough income that a piece of that Social Security income is taxable (which would have to be fairly significant, we’re talking tens of thousands of dollars), it would either be taxed as a Kiddie Tax, or the child could file his or her own return.

Like I said before, this certainly doesn’t cover the whole gamut of Kiddie Tax issues, but they’re the ones I’ve seen.