Kiddie Tax Age Limit Change

The Kiddie Tax rules have changed for tax year 2008. In May 2007, Congress amended the Kiddie tax rules again as part of the Iraq spending bill. The Kiddie Tax age limit increased for 2008 to affect children's investment income through age 18 and full-time students through age 23. The prior rules impacted children's investment income through age 17.

History of the Kiddie Tax

The Kiddie Tax was first established in 1986 to keep parents from shielding income by placing investment accounts in the names of their children, who typically were in lower income tax brackets. Under the Kiddie Tax, a portion of the investment earnings held in a child's name was tax free, the next portion was taxed at the child's marginal tax rate and any amount over the second earnings limit was taxed at the parents' marginal tax rate.

The initial Kiddie Tax rules expired when a child turned 14. The age level was increased to 18 (through age 17) under the Tax Increase Prevention and Reconciliation Act of May 17, 2006. This revision was retroactive to January 1, 2006.

In 2008, this age threshold further increased to cover children through age 18 and full time students through age 23. To be considered a full-time student, a child must be enrolled full-time in school for at least five calendar months in the year.

The Kiddie Tax now ceases to exist at the beginning of the year the child turns 19 (or 24 for full-time students). From this year forward, the child is taxed as any unmarried taxpayer. Further, it should be noted that the Kiddie Tax does not apply to married couples filing a joint return.

Kiddie Tax Facts:

It affects children through age 18 or 23 for full-time students.
It only applies to unearned income, which is typically investment income held in the child's name. Income from other sources, such as employment, is not affected by the Kiddie tax.
For 2008, only unearned income over the annual earnings limit of $1,800 is taxed under the Kiddie Tax rules.
Kiddie Tax does not apply to married couples filing a joint return.
Kiddie Tax does not apply if the earned income of a student over age 18 exceeds half of the child's living expenses. Living expenses include food, housing, clothing, medical, dental, education and other necessary costs of support. Students over 18 are considered independent from their parents if they provide more than 50% of their own support.

Calculation of the Kiddie Tax

As noted earlier, the first portion of unearned income is tax free. In 2008, this amount is $900. The next $900 in investment income is taxed at the child's tax rate. This rate can be as low as 5% on long-term capital gains and dividends and no more than 10% or 15% for short-term capital gains and interest. Any income above $1,800 is taxed at the parents' rates - 15% for dividends and long-term capital gains and as much as 35% on short-term capital gains and interest. The stated investment income levels ($900 tax free, etc.) will be periodically adjusted for inflation in future years.

Earned vs Unearned Income

It is important to understand that the Kiddie Tax only applies to unearned income, typically investment income. Income earned through employment, such as weekend jobs or part-time work, is taxed at the child's marginal tax rate with no Kiddie Tax impact. A child will pay no tax on earned income up to $5,450 in 2008 due to the standard deduction. The standard deduction amount will increase with the annual inflation adjustment.

Filing of the Kiddie Tax

If the Kiddie Tax affects your child, you will need to complete IRS Form 8615 to calculate the amount of the Kiddie Tax. This form is then filed with your child's Annual Tax Return - Form 1040.

Parents can alternatively elect to report child's unearned income on their return. A parent of a child under 19 can do this by filing IRS Form 8814 with your Form 1040 and paying the entire federal income tax (including the Kiddie Tax). This option, however, is only available if your child's income is solely unearned income from interest, dividends and capital gain distributions and is no more than $8,500. If the parent makes this election, the child does not have to file a return.

Example: Despite the change in the age limits, there are still savings by placing investments in your child's name. For example, your 16 year old generated $6,000 in investment income in 2008. The first $900 is tax free, the second $900 at 10% (interest and short term gains or 5% for dividends and long term gains) and the next $4,200 at the parents' marginal tax rate in this example - 35% (or 15% for long term capital gains). The tax due on the $6,000 is $1,560. Under the parents' rate, the tax due would be $2,100 or a difference of $540 per child.

Posted: July 2008

In need of accounting services? Please contact our office to talk to one of our professionals about your accounting needs and how we may be of service.

Bassman, Adelman & Weiss, PC
630 Sentry Parkway East, Suite 200
Blue Bell, PA 19422
voice: 215-628-0420
fax: 215-628-3461
email: Bassman, Adelman & Weiss
print: driving directions