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Your New Baby

Children's Taxes, Tax Returns, and the Kiddie Tax

Naturally, you want to minimize taxes in order to keep your hard-earned money from disappearing. Shifting assets to your children (who have a lower tax bracket) is one way to accomplish this.

How do you get the money to your child?

  1. Tax-Free Gifts. Thanks to the "gift-tax exclusion," in 2019 you can give up to $15,000 ($30,000 if you give gifts jointly with your spouse and elect to split the gifts) to as many individuals as you wish. The recipients do not have to pay a gift tax on this money. However, if in 2019 your kindness is greater than $15,000 (or $30,000 jointly) a year, you—as the donor—may be subject to the gift tax on the excess. For lifetime transfers, there is also an applicable credit amount that allows you to transfer up to $11.4 million during your lifetime free of gift tax. Any amount gifted over $11.4 million is subjected to current gift tax. There are also gift tax exclusions, such as payments on behalf of a donee for health care and/or educational expenses paid directly to the provider. The gift tax rates are generally the same as the estate tax rates (in 2019, the top rate is 37%).
  2. Transfer Growth Stocks. You can cut your capital gains tax on appreciated stocks by transferring them into your child's custodial account. This type of stock is purchased in anticipation of its rising in price. Growth stocks typically pay very low or no dividends, which are currently taxable. Sell the stock only after your child turns 19, or age 24 if a full-time student. At that point, the capital gain portion is taxed at your child's tax rate, which could be as low as 0%. Growth stock investments for your child's benefit make good sense when your child is a newborn since he or she has more than ten years before college. This type of investment yields little or no immediate income, so you'll have minimal tax to pay.
  3. Transfer Appreciated Investments. As with growth stocks, when these securities are sold, the profit or gain will be taxed at the child's lower rate, not your higher one, unless the "Kiddie Tax" rules apply (see below).

The "Kiddie Tax"

Now that your child has investments in their name, how is the income from these investments taxed?

The answer can be found in the "Kiddie Tax" Rules. This tax was created in 1986 because parents had been putting money in their child's name so that the income earned would be taxed at the child's lower tax bracket rather than at the parent's higher one. To put an end to this, Congress came up with a new set of rules, the key one being that if a child under age 19 or age 24 if a full-time student (the age was 14 prior to 2006 and was age 18 in post 2005 tax years) has unearned income over a certain amount (that amount is adjusted annually), that extra amount is taxed at the parent's marginal federal income tax rate (unearned income is income from investments, such as stocks, bonds, CDs, and savings accounts). Here's how it works:

In 2019 if your child is under age 19 or if a full-time student under age 24 and has unearned income of $1,100 ($1,050 in 2018) or less, there is no tax.

If the unearned income is between $1,100 and $2,200 in 2019 ($2,100 in 2018) the income is taxed at the child's tax rate.

If your child has more than $2,200 in 2019 ($2,100 in 2018) of unearned income per year, he or she will be taxed at your rate, which is probably higher than the child's income tax rate.

Any income your child has that's earned (from working) is taxed at their rate.

Once your child reaches age 19, all of their income is taxed at their rate. IRS Publication has more details on the Kiddie Tax calculations.

Filing Tax Returns for Your Child

When your children have income, they must pay taxes. However, they may not need to file their own tax return. If they are under age 19, or age 24 if a full-time student, and have income of between $1,100 ($1,050 in 2018) and $11,000 ($10,500 in 2018) consisting only of interest and dividends that were not subject to backup withholding, and they made no estimated payments, you may elect to include the child's income on your return. If you elect to do this, enter their income as "other income" on your return and file Form 8814.

This may boost your taxable income, put you in a higher tax bracket and, therefore, work to your disadvantage; or, it may work to your advantage if you can deduct more investment interest expense because of your child's income inclusion.

If you do not include the child's income on your tax return, then they may be required to file their own return and Form 8615.

Let's summarize:

 

2019 Form 8814

2019 Form 8615

 

Parents include Child's Unearned Income

Child Files Own Tax Return for Unearned Income

Under age 19 or a full-time student under age 24

First $1,100 ($1,050 in 2018) is tax free

First $1,100 ($1,050 in 2018) is tax free

 

$1,101 to $2,200 ($2,100 in 2018) taxed at 10%.

Dividends and the long-term capital gain portion are taxed at a maximum rate of 0%

$1,101 to $2,100 ($2,100 in 2018) taxed at 10%.

Dividends and the long-term capital gain portion are taxed at a maximum rate of 0%

 

Over $2,200 ($2,100 in 2018) is taxed at parents' tax rate

Over $2,200 ($2,100 in 2018) is taxed at parents' tax rate

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax professional.

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