Believe it or not, the tax code applies to our precious little ones long before they ever reach the wonderful age of 18 years and pass into adulthood. Any investment savings or income earned by children is technically tax-eligible, depending how much is actually earned. Because kids are under the age of adulthood, it is their parents’ or guardian’s responsibility to account for this income at tax time.
Most of us scoff immediately at the idea that little kids earn much of anything, much less that it should be subject to taxes. However, in reality, kids can collect a tidy sum of cash annually, especially if every gift is put into a bank account rather than spent. For example, if a child had taken every $100 gift received in 2008 and put it into a mutual fund that invested in the stock market when troughed right after the 2007 fall-off due to the mortgage crisis. The mutual fund gain would be significant, as well as taxable.
The major issues to remember can be lumped into four main categories to watch out for. So next time Grandma comes around with a gift for Christmas or a birthday for junior, think for a moment how the money deposit will play out when its time to file.
First off, income earned on investments either through gains or interest can be taxable. This can include direct interest, dividend payments, value growth such as capital gain, and any passive income received. The child’s earnings however are linked to that of the parents or legal guardian. As a result, the applicable tax rate is then what applies to the parent or guardian’s income taxes for the year, not the child.
Second, there is an age requirement, as mentioned earlier, and a dollar threshold involved. The parent or guardian’s tax rate applies to income that exceeds $1,900 and if the child was under 18 years old by Dec. 31 of the tax year. The same rate also applies if the child did turn out to be 18 years old before the tax year ended but did not personally earn more than half her living support independently (i.e. the child was still living at home paid for by mom and dad instead of on her own in her own apartment, etc.).
An exception to the rule is made for college students. If a child is over 18 years old and under 24 years and is studying full-time, and didn’t have any income from a job that totaled more than 50 percent of living support for the year, then the applicable rate is still that of the parents or guardian. Otherwise, the rate that should be applied is that of the adult child filing his or her own taxes annually.
Don’t think that you can skip reporting either. As banks and investment organizations pay out gains or interest on accounts, the activity generates an IRS 1099-INT or a 1099-B form. The account administrator then sends the account holder and the IRS a copy of what was earned on the account. If the IRS doesn’t see the same information appear on a related tax income filing, the mismatch can then trigger an audit review.
To process this information, IRS Form 8615 – Tax for Certain Children Who Have Investment Income of More than $1,900, is used to calculate any applicable federal taxes and declare them. This form is then attached to your annual income tax filing such as an IRS Form 1040 or 1040A. It’s worth checking out Form 8814 – Parents’ Election To Report Child’s Interest and Dividends, as well. If eligible, a parent can include a child’s earnings statement within his own tax filing rather than as a separate report.
Additional detail and more in-depth information can be found by referring to IRS Publication 929 – Tax Rules for Children and Dependents. Both this manual and the forms mentioned above are all accessible via the Internet by going to the IRS’ website, www.IRS.gov and downloading them as PDF files. Additionally, you can always request a hardcopy be mailed to you by using a phone and calling 800-TAX-FORM (800-829-3676).
IRS Form 8615, Tax for Certain Children Who Have Investment Income of More Than $1,900
IRS Form 8814, Parent’s Election to Report Child’s Interest and Dividends
IRS Publication 929, Tax Rules for Children and Dependents
Bankrate; IRS Rules for Child’s Investment Income; Kay Bell; March 2009