There are two rules that will help determine if investment and other unearned income of children should be reported for tax purposes. The IRS has established the following rules:
- If the child’s interest, dividends, and other unearned income total more than $2,100, part of the income may be subject to tax at the parent’s tax rate instead of the child’s tax rate (see Form 8615), or
- If the child’s only income is interest and dividend income (including capital gain distributions) and totals less than $10,500, the child’s parent may be able to elect to include that income on the parent’s return rather than file a return for the child (see Form 8614).
Specifically, a child’s tax return (Form 8615) will be filed if number one above applies to your situation. In addition to the requirement of $2,100 in unearned income, there are four other requirements:
- The child must meet one of the following requirements:
- The child was under age 18 at the end of the year
- The child was 18 but less than 19 at the end of the year and the child’s earned income did not exceed a half of the child’s own support for the year, or
- The child was a full-time student who was at least 19 and less than age 24 and the child’s earned income did not exceed a half of the child’s own support for the year
- At least one of the parents was alive at the end of the year
- The child is required to file a tax return for the year, and
- The child does not file a joint return for the year.
The difference between unearned income and earned income is pertinent when determining whether or not a child’s tax return should be filed. Unearned income includes taxable interest, ordinary dividends, capital gains (and capital gain distributions), rents, royalties, taxable Social Security benefits, pension and annuity income, taxable scholarship and fellowship grants not included on Form W-2, unemployment compensation, alimony and income (not earned) received as a beneficiary of a trust. Earned income includes wages, tips, and other payments received for personal services.
It is important to note that the child may be subject to the Net Investment Income Tax (NIIT). This is a 3.8% tax on the lesser of net investment income or the excess of the child’s Modified Adjusted Gross Income over a threshold amount. This additional tax can be determined by completing Form 8960, Net Investment Income Tax.
For more detail on Form 8615, the form instructions can be viewed on the IRS website. Contact your Somerset CPA advisor at 317-472-2200 or to further discuss this topic.
