Inside: Learn about Kiddie Tax, How can you as a parents save the money & understand how to apply for it
The Kiddie Tax might sound cute, but it’s an important tax rule that parents and guardians need to know about in 2024. Basically, it stops families from paying less tax by putting money in their kids’ names, who are usually taxed at a lower rate. If you’ve heard about it before but find it all a bit confusing, don’t worry. In this blog post, we’re going to break down what the Kiddie Tax is, how it works, and what you can do about it in simple terms. Whether you’re totally new to this or just looking for the latest updates, we’ve got you covered with easy-to-understand information to help you make sense of it all.
What is Kiddie Tax?
The Kiddie Tax applies to the unearned income of children under the age of 18, or under the age of 19 to 24 if they are dependent. Unearned income includes money earned from investments, such as dividends, interest, capital gains, and distributions from a trust etc. This tax was first introduced in 1986 under Tax Reform Act and has undergone several changes since then, mainly in 2017.
To whom Kiddie Tax applied & How it is calculated?
The Kiddie Tax functions as a measure to curb the practice of shifting substantial wealth into children’s accounts for the sake of tax reduction, applying to those under 18 years of age and dependent students aged 19 to 24. Once a child’s investment income surpasses $2,500 within a year, the Kiddie Tax kicks in.
The tax treatment segments the income into three parts: the initial $1,250 of the child’s unearned income remains untaxed, the subsequent $1,250 is taxed according to the child’s own tax rate, and any amount exceeding $2,500 is subjected to taxation at the parents’ or guardians’ higher marginal tax rate.
Additionally, there exists an option for parents to report their child’s interest and dividends on their own return using Form 8814, thereby simplifying tax filing and potentially avoiding the need for the child to file separately. This regulation is specially designed to ensure that unearned income received by children is taxed in a manner that reflects the tax bracket of the family, rather than at the child’s likely lower tax rate.
How to apply for Kiddie Tax IRS
To apply the Kiddie Tax, taxpayers must follow specific IRS guidelines detailed under Topic No. 553. When a child’s unearned income surpasses the annual threshold of $2,500, the Kiddie Tax provisions become applicable.
Parents or guardians are required to file Form 8615, “Tax for Certain Children Who Have Unearned Income,” to calculate the tax on the child’s income at the parents’ tax rate if it is higher than the child’s own rate.
This form connects the child’s tax details with that of their parents to ensure that the child’s unearned income is taxed at a rate that reflects the family’s overall income level, thereby preventing tax avoidance through income shifting to minors. It’s crucial for families to carefully review these guidelines to determine their obligations and to accurately report and calculate the Kiddie Tax where applicable.
Key Forms and Instructions
For applying Kiddie Tax, these two forms play important role:
- Form 8615: Required for certain children who have unearned income above the IRS threshold, ensuring this income is taxed at the appropriate rate.
- Form 8814: This form allows parents to choose to include their child’s interest and dividends on their tax return, for simplifying the filing process.
Both forms come with instructions that guide parents and guardians through the process of reporting and paying the Kiddie Tax.
Conclusion
In conclusion, the Kiddie Tax is a tax provision designed to prevent high-income families from shifting income to their children in order to take advantage of lower tax rates. This tax can significantly impact wealthy families and requires careful planning in order to minimize its effects. By understanding the rules and making strategic decisions about gifting and investing, parents can help reduce their children’s exposure to the Kiddie Tax. It is important for individuals and families with significant investment income to consult with a tax advisor or financial planner in order to make informed decisions and optimize their overall tax situation.
Note: Kiddie Tax rules are subject to change or updates, we recommend you to consider reading IRS guidelines before making any decision.