Note: This post, originally published on March 15, 2017, has been updated to include changes brought by the 2018 Tax Cuts and Jobs Act. These changes are indicated in blue italics.
Our high net worth clients often want to get their children interested in finance and investing at a young age. Along with this desire comes setting up brokerage accounts, which may produce taxable income to the child. There are two different ways to report your child’s unearned taxable income: the parents can report it on their tax return by attaching Form 8814 to their Form 1040, or the child can report in on their tax return by attaching Form 8615 to their Form 1040.
There are certain requirements that need to be met for the parents to report their child’s unearned income on Form 8814 on their personal Form 1040, rather than having the child file a separate 1040:
- The child must qualify as a dependent;
- The child must only have income from interest, dividends, or capital gain distributions in the total amount of less than $10,500;
- The child must not otherwise be required to file a separate tax return; and
- The child must not have made any estimated tax payments, had a prior year over-payment applied to estimated taxes or had any backup withholding on the income.
If you choose to report the income on Form 8814, this form will calculate the tax due on the first $2,100 of the child’s unearned income. Any amounts over $2,100 will be added to the income reported on the parents’ Form 1040 and taxed there accordingly. The Tax Cuts and Jobs Act has simplified the method for calculating tax on a child’s unearned income. Previously it was taxed at their parents’ tax rate; but for 2018 through 2025, the tax rates will be the same as those used for estates and trusts.
Reporting a child’s income on the parent’s personal Form 1040 has both advantages and disadvantages. One advantage is a decreased number of family tax filings. Some of the disadvantages include losing the child’s deductions, which may offset this income, or having to pay tax on this income at a higher rate.
Another option is for the child to file their own Form 1040 to report the unearned income. In this scenario, Form 8615 needs to be included in the following situations:
- The child’s unearned income is more than $2,100,
- The child is required to file a tax return,
- The child is in the age-range to be classified as a dependent,
- The child’s unearned income is more than half of what they paid to support themselves,
- The child has at least one parent who is alive, and
- The child is not filing a joint tax return.
In this situation, unearned income includes interest, dividends, capital gains, taxable social security and pension payments, certain distributions from trusts and unemployment compensation.
Once the amount of unearned income is determined, the amount will also be taxed at the same rates as estates and trusts. An advantage of having the child file their own tax return is the ability to use deductions to offset unearned income or potential lower tax rates. A disadvantage is having to perform additional tax filings.
Please contact your Clark Nuber professional if you would like to discuss methods of reporting your child’s unearned income.
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