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Your Kids And Their Taxes


Continuing the theme of taxes (tis the season, after all), let’s explore what you need to know about your kids and their taxes. 

Children - even very young ones! - can participate in the economy through bank and investment accounts in their name. The interest, dividends, and capital gains these generate are the child’s unearned income. Older children might have earned income from jobs. But because we’re talking about dependents, or people who are still claimed on someone else’s return and who don’t support themselves, different rules apply for determining the requirements for filing a tax return and understanding what is owed. 

So, you’ve received a bunch of 1099s in your kids’ names and you need to understand the requirements. The IRS provides a worksheet to help figure it out:

Kiddie tax rules for unearned income

Funneling investments and income-producing assets to kids used to be a way for families to pay much less tax than they otherwise should have (the kids would have been in very low brackets), so naturally it got recklessly abused and now everyone has to pay more. Since the 1980s, children’s unearned income above a threshold has been subject to their parents’ marginal tax rates (there was a brief blip when it was actually subject to the even higher trusts and estates rate, but that got repealed). In practice, this means that for each child, for tax year 2021:

  • the first $1,100 of a child’s unearned income qualifies for the dependents’ standard deduction. If your child (each of them individually) didn’t have more than that amount in income, dividends, and capital gains in 2021, nothing needs to be reported

  • the next $1,100 is taxed at the first income bracket, or 10%

  • anything above that is taxed at the parents’ marginal rate

If a return needs to be filed, should the child file their own or should the parents elect to report it on their own return?

If certain requirements are met (most importantly, that it’s only unearned income in question, and that it’s less than $12,200), parents can elect to report their children’s income on their own return. The simplicity of avoiding more returns should be weighed against the impact of the income on the parents’ return itself, like possible lost deductions from higher income

What about kids with earned income?

Earned income (from employment) is not subject to kiddie tax rules and their return should be filed, even if they amount they earned is less than the standard deduction (for this it’s the regular $12,550), the child might be owed a refund if taxes were deducted from their pay. And of course, that will allow them to fund a Roth IRA!

What about parents who aren’t married or don’t file jointly?

  • If the parents are married but filing separate returns, use the parent's return with the higher taxable income.

  • If the parents were never married, but they live with each other for the whole year, use the return of the parent with the greater taxable income.

  • For parents who are divorced or living apart:

  • If they are divorced and considered unmarried, or if they do not live with each other the whole year, use the return of the custodial parent (the parent the child lives with most of the year).

  • If the custodial parent is not considered unmarried, use the parent's return that has the higher taxable income.

  • If the child's custodial parent is divorced and has not remarried, use the custodial parent's return

  • If a parent remarries:

  • If one parent dies, and the widow or widower remarries, treat the stepparent as the child's other parent. If the parent and stepparent file a joint return, use that return. If they file separate returns, use the return with the higher taxable income.

  • If the divorced custodial parent has remarried, treat the stepparent as the other parent.

  • If the custodial parent remarried but is not living with his or her spouse, use the custodial parent's return, as long as the custodial parent is considered unmarried for filing purposes. If the custodial parent is considered married for the tax year, use the parent's return with higher taxable income.

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