There are a group of special tax rules relating to the unearned income of a minor child. Collectively, these interrelated rules are referred to as the "kiddie tax." These special rules tax the unearned income (interest, dividends, investments, etc.) of a minor child at the parents' highest marginal tax rate if the child's unearned income exceeds $1,900 in 2011 (indexed for inflation). Parents may avoid this by electing to include the child's income on their own return.
If the election isn't made, and the child files a separate return, no personal exemption is allowed if the child could have been claimed as a dependent on his or her parents' return. However, up to $950 for 2011 of the child's standard deduction can be used to offset unearned income. This amount is also indexed for inflation.
If the "kiddie tax" applies, it can lead to the unearned income of the child being taxed at a higher rate than the parents pay on their income. This would occur when the parents' income is very close to the point at which rates go up, for example, from 25 percent to 28 percent. The kiddie tax computation adds the child's unearned income to the amount reported on the parents' return to determine the applicable marginal tax rate. This could result in much or all the child's unearned income being taxed at the higher rate.
There are different classes of children affected by the "kiddie tax." As noted above, these rules interact with the parents' decision whether or not to make the special election. That decision depends on the parents' tax position, and on whether making the election results in a net tax saving for the family as a whole. For 2011:
- If a child is under 18 on December 31 -- The kiddie tax will apply if the child has more than $1,900 in unearned income.
- If a child is under age 19 (under age 24 if a full-time student) on December 31 - The kiddie tax will apply if the child has more than $1,900 in unearned income and does not have earned income in excess of one-half of his or her support.
If a minor child is required to file a return, the parents have two options.
- Reporting the income on the child's own return
- Reporting the child's income on the parents' return