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Back To School 2014: Saving & The Kiddie Tax

Back To School 2014: Saving & The Kiddie Tax 810Tax

I think one of the best things that you can teach your kids is the value of money. Obviously, parents are going to disagree about the specifics but the basics – what it is, how you use it, the importance of spending or saving it wisely – are pretty universal.

When it comes to kids saving and earning money, it may also be time to talk kiddie tax. The kiddie tax is the tax imposed on kids at the parents’ tax rate and not at the lower rate of the child when income reaches certain thresholds. The rules can be tricky and depend on a number of factors, including the age of the children, as well as the amount and source of the income.

If kids work for their money, it’s generally considered earned income; tips for servers are also considered earned income. The general rule for kids (and dependents) is that if income is earned and that amount is less than the filing threshold (it’s $6,100 for 2014), there’s no need for that child to file a federal income tax return; a quick caution, though, that if a taxpayer is subject to self-employment tax, the threshold is generally $400 of net earnings (more on filing requirements in a future post).

The rules are different when income is unearned. Unearned income is generally investment income, like income from dividends and interest. For 2014, children under the age of 18, or under the age of 24 while a full time student, the first $1,000 is considered tax-free and the next $1,000 is taxed at the child’s rate. Unearned income over $2,000 is taxed at the child’s parents’ tax rate. Income which is taxed at the child’s parents’ tax rate does not necessarily mean that the income has to be included on the parents’ tax return; the child can opt to file a separate return (and in fact, that can sometimes be preferable for all kinds of reasons, including the AMT).

As of last year (2013), a child may also be subject to the new Net Investment Income Tax (NIIT). NIIT is the much maligned 3.8% surtax for high income taxpayers. When it comes to kids, the NIIT applies to the lesser of net investment income or the excess of the child’s modified adjusted gross income (MAGI) over the threshold amount (more on the NIIT here).
That, of course, assumes that everything is easy. Sometimes, arrangements aren’t so clear cut. If the child’s parents are divorced, generally, the kiddie tax is reported on the custodial parent’s tax return. In the event that the child’s parents are unmarried – and have never been married to each other – or if the child’s parents are married but filing separate, the kiddie tax is calculated using the parent’s return with the highest taxable income.

Keep in mind that these rules apply to children who are dependents. Those who are not dependents because of their age or filing status (such as children who are married), level of support or those who are emancipated have a different set of rules.

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