It’s fairly typical not to expect children to file tax returns. Often they have no income, usually they are young enough to be considered dependents of their parents, and for the first ten to fifteen years they tend not to have the knowledge to fill out a 1040. For the most part, it’s expected that a parent will simply include their children as dependents, or for an older child with a part-time job, file that child’s return for them. But there are a number of special cases where things happen differently. One example of this is when a child has investment income. Because this is income, it’s taxable, but because it’s not earned income the way paychecks from a part-time job would be, the situation needs some special handling. Here are the tax rules for children with investment income.
First, the child needs to be required to file a return to begin with. For children 18 or younger who meet the criteria to be dependents of their parents, this means they made more than $1,050 in unearned income and had no other income. If the child is required to file a return but has made less than $10,500, the parent may opt to include this income on their own return rather than file one for the child.
If the child files their own return, their tax amount is determined by filling out IRS Form 8615, Tax For Certain Children With Investment Income. Form 8615 figures the child’s tax rate based on their gross income and the tax rate of their filing parent. Income reported on Form 8615 may also be subject to a 3.8% Net Investment Income Tax.
If the parent includes the child’s investment income on their tax returns, they must fill out IRS Form 8814, Parents’ Election To Report Child’s Interest And Dividends, and attach it to their Form 1040 tax return. Form 8814 applies a child’s tax rate to the first $2,100 of their investment income, and the parent’s tax rate to the remainder, up to $8,400. Remember, a child making more than $10,500 in unearned income must file his or her own tax return. This rule was largely instituted to prevent parents from sheltering funds at a lower rate or attempting tax debt reduction by claiming their own investment income as their child’s.
The tradeoff here is generally one of convenience. Having the child file their own return is a bit more complicated, but the tax benefit is greater. Including the child on your tax return is often easier, but as their parent you aren’t able to take some of the benefits that a child can. Either way, the rules are clear: if a child has investment income over a certain amount, it needs to be reported and taxes paid, no matter how young the child may be.