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Do Children Need to File Their Own Returns For Unearned Income (Dividends)?

Do Children Need to File Their Own Returns For Unearned Income (Dividends)?
Ines Zemelman, EA
24 February 2022

How to treat children’s unearned income – to report on parent return (form 8814) or file separate return (with form 8615)?

  • If a child has only interest and dividends – use Form 8814 on Parent’s return
  • Explore tax optimization – tax may be lower by filing individually child return
  • If Capital gains – child needs separate return (with form 8615) – no other choice

Do you pay taxes on the unearned income of children?

If your child has unearned income more than $2,200, it will be taxed at parent’s marginal tax rate.  The amount of tax depends upon the amount of minor’s unearned income and whether the child is filing a separate tax return or parent is electing to include the child’s income on their tax return.  Kiddie tax was put into effect to discourage parents from transferring ownership of their investments to their children whose tax rate is lower.

How to file unearned income of Children: Form 8814 — Reporting children's income on Parent's return

Parents can elect to include their child’s interest and dividend income including capital gain distributions on their tax return instead of filing a separate tax return for the child.  You can make this election by attaching Form 8814 to your Form 1040 and the child must meet all of the following conditions.  Separate Form 8814 needs to be attached for each child for whom the election is made.

  • Your child was under age 19 (or under age 24 if a full-time student) at the end of the year.
  • Your child’s only income was from interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends).
  • The child's gross income was less than $11,000.
  • The child is required to file a return unless you make this election.
  • The child doesn’t file a joint return for the year.
  • There were no estimated tax payment made for the year, and no overpayment from the previous year (or from any amended return) was applied to this year under your child's name and SSN.
  • There was no federal income tax was withheld from your child's income under the backup withholding rules.
  • You are the parent whose return must be used when applying the special tax rules for children. 

Restrictions on certain tax benefits

If you are making Form 8814 election, you can’t take any of the following deductions that the child would be entitled to on his or her tax return

  • The additional standard deduction if the child is blind.
  • The deduction for a penalty on an early withdrawal of your child's savings.
  • Itemized deductions (such as your child's investment interest expenses or charitable contributions).

If your child received qualified dividends or capital gain distributions, you may pay up to $110 more tax if you make this election instead of filing a separate tax return for the child. This is because the tax rate on the child’s income between $1,100 and $2,200 is 10% if you make this election. However, if you file a separate return for the child, the tax rate may be as low as 0% (zero percent) because of the preferential tax rates for qualified dividends and capital gain distributions.

Additionally, if the adjusted gross income is a higher amount, there are chances that certain deductions or credits such as child tax credit, earned income credit, the deduction for student loan interest, etc may be reduced on your return.

Depending on your income level, it would be better to calculate the tax as if you are electing to report your child’s income on your tax return and also the child is filing his or her own return.  Then compare the tax under two methods and choose the most beneficial option which results in the lower tax.

Form 8615 — Tax for children with unearned income

If the child’s unearned income is more than $2,200 and you don’t or can’t use Form 8814 to include your child's unearned income then it will be taxed at the parent’s rate if the parent’s rate is higher than the child’s.  This is often called kiddie tax. A child must file Form 8615 to figure the tax if all of the following conditions are met.

  1. At least one of the child’s parents was alive at the end of the year
  2. The child does not file a joint return for the year
  3. The child has an unearned income of more than $2,200 
  4. The child is required to file a tax return
  5. The child either:
    1. Under age 18 at the end of the year
    2. Age 18 at the end of the year and didn’t have earned income that was more than half of his or her support or
    3. A full-time student at least age 19 and under age 24 at the end of the year and didn’t have earned income that was more than half of his or her support. 

How is a child's unearned income taxed

The first $1,100 of child’s unearned income is tax free since there is a standard deduction of $1,100.  If the parent elects to include the child’s income on their return, the next $1,100 will be taxed at a 10% and the additional tax is the smaller of:

  1. 10% of your child’s gross income minus $1,100, or
  2. $110 

If the child is filing a separate return, then unearned income more than $2,200 is taxed at parent’s tax rate

What is unearned income for a child

Kiddie tax unearned income includes all taxable income other than earned income such as interest, ordinary dividends, capitals gains including capital gain distributions, rents, royalties, taxable social security benefits, pension, and annuity income, unemployment compensation, alimony, taxable scholarship, and fellowship grants not reported on the child’s W-2, etc. 

  • If you are a TFX client and your child needs a separate return due to this situation, you will be entitled to a discount on the second return.
  • This is only available if the return is simple (only investment income).  If the child has other income – this does not apply.

The IRS treats dependent children differently depending on whether they earn money from work or through investments

All dependent children who earn less than $12,550 of income in 2021 do not need to file a personal income tax return. If earn $12,550 or more they must file and might owe tax to the IRS. Earned income only applies to wages and salaries your child receives as a result of providing services to an employer, even if only through a part-time job.

Even if your child earns less than $12,550 in 2021, it may be a good idea to file a tax return for them, because they could be eligible for a tax refund.

Regardless of whether the child files their own tax return to report earned income or does not file, child wages are NEVER included to parent’s tax return.

Dependent children must file a tax return if they have:

  • Unearned income (Capital gains, Interest, Dividends, Rents, Trust Distributions, Pension) of more than $11,000, or
     
  • If a child’s only income is interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends), the child was under age 19 at the end of 2021 or was a full-time student under age 24, a parent can elect to include the child’s unearned income on the parent’s return. If this election is made, the child doesn’t have to file a return.

The IRS table below shows decision tree for determination whether child income can be reported on parent return or not.

Ines Zemelman, EA
Founder of TFX