Junior’s Investment Income May Be Taxable
April 09, 2014I have four children, two of which have custodial accounts. By definition, those custodial accounts belong to my children, and when they reach the age of majority—18 in most states—they technically can take that money and use it for whatever their hearts desire. Until then, I’m the custodian of the account, and as the custodian, it is my responsibility to make sure the money is managed properly. Not only does that mean making sure the assets are invested wisely, but also making sure that any taxes associated with the account are reported accurately.
Rather than keep the money in a bank account earning next to nothing in interest, I’ve decided to invest the money in mutual funds. The mutual funds I’m using distribute interest and capital gains each year, so the question is how do I report this information, if at all, to the IRS? Here are a few things the IRS would like us parents to know as it relates to reporting a child’s investment income:
Investment income includes interest, dividends and capital gains.
Whether it is interest earned in a bank savings account, dividends from stock, or capital gains distributed from a mutual fund, a child’s investment income falls under a set of tax rules commonly referred to as the “Kiddie Tax.” Under these rules, the first $1,000 of investment income is tax free, and the next $1,000 of investment income is taxed at the child’s tax rate. Investment income in excess of $2,000 is taxed at the parent’s marginal tax rate.
If your child’s investment income is below certain thresholds ($10,000 in 2013), you may be able to include the income on your tax return.
You may choose to report your child’s income on your tax return by completing Form 8814, Parents’ Election to Report Child’s Interest and Dividends. If you decide to do this, you will not have to file a separate tax return for your child.
If your child’s investment income is above this threshold, your child must file their own tax return.
You will complete a tax return on behalf of your child as though he or she were just like any other taxpayer. You may still claim your child as a dependent on your tax return; just make sure you don’t also claim an exemption for your child on their tax return. Include Form 8615, Tax for Certain Children Who Have Unearned Income, when you file your child’s federal tax return.
Starting in 2013, any tax your child reports on Form 8615 may also be subject to the Net Investment Income Tax (NIIT).
This is a 3.8% tax on the lesser of either net investment income or the excess of your child’s modified adjusted gross income over a certain threshold. If your child is subject to this tax, you will complete Form 8960, Net Investment Income Tax, and include it with your child’s return.
My children are too young to have a job, so for now the only income I have to deal with is investment income. Since there’s not a lot of money in their accounts right now, it’s really not that bad. But some day they may decide to work, and when they do, I’ll have to start reporting that income as well. To learn more about the filing requirements and tax implications of a child’s earned income, see Publication 929, Tax Rules for Children and Dependents.