31.   Tax on Unearned Income of Certain Children

What's New

Net Investment Income Tax. . For tax years beginning after December 31, 2012, a child whose tax is figured on Form 8615 may be subject to the Net Investment Income Tax (NIIT). NIIT is a 3.8% tax on the lesser of the net investment income or the excess of the child's modified adjusted gross income (MAGI) over the threshold amount. Use Form 8960, Net Investment Income Tax, to figure this tax. For more information on NIIT, go to www.irs.gov and enter “Net Investment Income Tax” in the search box.

Introduction

This chapter discusses the following two rules that may affect the tax on unearned income of certain children.

  1. If the child's interest and dividend income (including capital gain distributions) total less than $10,000, the child's parent may be able to choose to include that income on the parent's return rather than file a return for the child. (See Parent's Election To Report Child's Interest and Dividends , later.)

  2. If the child's interest, dividends, and other unearned income total more than $2,000, part of that income may be taxed at the parent's tax rate instead of the child's tax rate. (See Tax for Certain Children Who Have Unearned Income , later.)

For these rules, the term “child” includes a legally adopted child and a stepchild. These rules apply whether or not the child is a dependent.

Useful Items - You may want to see:

Publication

  • 929 Tax Rules for Children and Dependents

Form (and Instructions)

  • 8615 Tax for Certain Children Who Have Unearned Income

  • 8814 Parents' Election To Report Child's Interest and Dividends

Which Parent's Return To Use

If a child's parents are married to each other and file a joint return, use the joint return to figure the tax on the child's unearned income. The tax rate and other return information from that return are used to figure the child's tax as explained later under Tax for Certain Children Who Have Unearned Income .

Parents Who Do Not File a Joint Return

For parents who do not file a joint return, the following discussions explain which parent's tax return must be used to figure the tax.

Only the parent whose tax return is used can make the election described under Parent's Election To Report Child's Interest and Dividends .

Parents are married.   If the child's parents file separate returns, use the return of the parent with the greater taxable income.

Parents not living together.   If the child's parents are married to each other but not living together, and the parent with whom the child lives (the custodial parent) is considered unmarried, use the return of the custodial parent. If the custodial parent is not considered unmarried, use the return of the parent with the greater taxable income.

  For an explanation of when a married person living apart from his or her spouse is considered unmarried, see Head of Household in chapter 2.

Parents are divorced.   If the child's parents are divorced or legally separated, and the parent who had custody of the child for the greater part of the year (the custodial parent) has not remarried, use the return of the custodial parent.

Custodial parent remarried.   If the custodial parent has remarried, the stepparent (rather than the noncustodial parent) is treated as the child's other parent. Therefore, if the custodial parent and the stepparent file a joint return, use that joint return. Do not use the return of the noncustodial parent.

  If the custodial parent and the stepparent are married, but file separate returns, use the return of the one with the greater taxable income. If the custodial parent and the stepparent are married but not living together, the earlier discussion under Parents not living together applies.

Parents never married.   If a child's parents have never been married to each other, but lived together all year, use the return of the parent with the greater taxable income. If the parents did not live together all year, the rules explained earlier under Parents are divorced apply.

Widowed parent remarried.   If a widow or widower remarries, the new spouse is treated as the child's other parent. The rules explained earlier under Custodial parent remarried apply.

Parent's Election To Report Child's Interest and Dividends

You may be able to elect to include your child's interest and dividend income (including capital gain distributions) on your tax return. If you do, your child will not have to file a return.

You can make this election only if all the following conditions are met.

  • Your child was under age 19 (or under age 24 if a full-time student) at the end of the year.

  • Your child had income only from interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends).

  • The child's gross income was less than $10,000.

  • The child is required to file a return unless you make this election.

  • The child does not file a joint return for the year.

  • No estimated tax payment was 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 social security number.

  • No federal income tax was taken out of 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. (See Which Parent's Return To Use , earlier.)

These conditions are also shown in Figure 31-A.

Certain January 1 birthdays.   A child born on January 1, 1995, is considered to be age 19 at the end of 2013. You cannot make this election for such a child unless the child was a full-time student.

  A child born on January 1, 1990, is considered to be age 24 at the end of 2013. You cannot make this election for such a child.

Full-time student.   A full-time student is a child who during some part of each of any 5 calendar months of the year was enrolled as a full-time student at a school, or took a full-time on-farm training course given by a school or a state, county, or local government agency. A school includes a technical, trade, or mechanical school. It does not include an on-the-job training course, correspondence school, or school offering courses only through the Internet.

How to make the election.   Make the election by attaching Form 8814 to your Form 1040. (If you make this election, you cannot file Form 1040A or Form 1040EZ.) Attach a separate Form 8814 for each child for whom you make the election. You can make the election for one or more children and not for others.

Effect of Making the Election

The federal income tax on your child's income may be more if you make the Form 8814 election.

Rate may be higher.   If your child received qualified dividends or capital gain distributions, you may pay up to $100 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 $1,000 and $2,000 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.

Deductions you cannot take.   By making the Form 8814 election, you cannot take any of the following deductions that the child would be entitled to on his or her 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 expenses or charitable contributions).

Reduced deductions or credits.   If you use Form 8814, your increased adjusted gross income may reduce certain deductions or credits on your return including the following.
  • Deduction for contributions to a traditional individual retirement arrangement (IRA).

  • Deduction for student loan interest.

  • Itemized deductions for medical expenses, casualty and theft losses, and certain miscellaneous expenses.

  • Credit for child and dependent care expenses.

  • Child tax credit.

  • Education tax credits.

  • Earned income credit.

Penalty for underpayment of estimated tax.   If you make this election for 2013 and did not have enough tax withheld or pay enough estimated tax to cover the tax you owe, you may be subject to a penalty. If you plan to make this election for 2014, you may need to increase your federal income tax withholding or your estimated tax payments to avoid the penalty. See chapter 4 for more information.

Figuring Child's Income

Use Form 8814, Part I, to figure your child's interest and dividend income to report on your return. Only the amount over $2,000 is added to your income. The amount over $2,000 is shown on Form 8814, line 6. Unless the child's income includes qualified dividends or capital gain distributions (discussed next), the same amount is shown on Form 8814, line 12. Include the amount from Form 8814, line 12, on Form 1040, line 21. Enter “Form 8814” on the dotted line next to line 21. If you file more than one Form 8814, include the total amounts from line 12 of all your Forms 8814 on Form 1040, line 21.

Capital gain distributions and qualified dividends.   If your child's dividend income included any capital gain distributions, see Capital gain distributions under Figuring Child's Income in Publication 929, Part 2. If your child's dividend income included any qualified dividends, see Qualified dividends under Figuring Child's Income in Publication 929, Part 2.

Figuring Additional Tax

Use Form 8814, Part II, to figure the tax on the $2,000 of your child's interest and dividends that you do not include in your income. This tax is added to the tax figured on your income.

This additional tax is the smaller of:

  1. 10% × (your child's gross income − $1,000), or

  2. $100.

Include the amount from line 15 of all your Forms 8814 in the total on Form 1040, line 44. Check box a on Form 1040, line 44.

Figure 31-A. Can You Include Your Child's Income On Your Tax Return?

Figure 31-A. Can You Include Your Child's Income On Your Tax Return?
Please click here for the text description of the image.

Figure 31–A. Can You Include Your Child's Income On Your Tax Return?

Tax for Certain Children Who Have Unearned Income

If a child's interest, dividends, and other unearned income total more than $2,000, part of that income may be taxed at the parent's tax rate instead of the child's tax rate. If the parent does not or cannot choose to include the child's income on the parent's return, use Form 8615 to figure the child's tax. Attach the completed form to the child's Form 1040 or Form 1040A.

When Form 8615 must be filed.   Form 8615 must be filed for a child if all of the following statements are true.
  1. The child's investment income was more than $2,000.

  2. The child is required to file a return for 2013.

  3. The child either:

    1. Was under age 18 at the end of the year,

    2. Was age 18 at the end of the year and did not have earned income that was more than half of his or her support, or

    3. Was over age 18 and under age 24 at the end of the year, was a full-time student, and did not have earned income that was more than half of his or her support.

  4. At least one of the child's parents was alive at the end of 2013.

  5. The child does not file a joint return for 2013.

These conditions are also shown in  
Figure 31-B.

Earned income.   Earned income includes salaries, wages, tips, and other payments received for personal services performed. It does not include unearned income as defined later in this chapter.

Support.   Your child's support includes all amounts spent to provide the child with food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. To figure your child's support, count support provided by you, your child, and others. However, a scholarship received by your child is not considered support if your child is a full-time student. See chapter 3 for details about support.

Certain January 1 birthdays.   Use the following chart to determine whether certain children with January 1 birthdays meet condition 3 under When Form 8615 must be filed.

Figure 31-B. Do You Have To Use Form 8615 To Figure Your Child's Tax?

Figure 31-B. Do You Have To Use Form 8615 To Figure Your Child's Tax?
Please click here for the text description of the image.

Figure 31-B. Do You Have To Use Form 8615 To Figure Your Child's Tax?

  
IF a child was born on... THEN, at the end of 2013, the child is considered to be...
January 1, 1996 18*
January 1, 1995 19**
January 1, 1990 24***
*This child is not under age 18. The child meets condition 3 only if the child did not have earned income that was more than half of the child's support. 
**This child meets condition 3 only if the child was a full-time student who did not have earned income that was more than half of the child's support. 
***Do not use Form 8615 for this child.

Providing Parental Information (Form 8615, lines A–C)

On Form 8615, lines A and B, enter the parent's name and social security number. (If the parents filed a joint return, enter the name and social security number listed first on the joint return.) On line C, check the box for the parent's filing status.

See Which Parent's Return To Use at the beginning of this chapter for information on which parent's return information must be used on Form 8615.

Parent with different tax year.   If the parent and the child do not have the same tax year, complete Form 8615 using the information on the parent's return for the tax year that ends in the child's tax year.

Parent's return information not known timely.   If the information needed from the parent's return is not known by the time the child's return is due (usually April 15), you can file the return using estimates.

  You can use any reasonable estimate. This includes using information from last year's return. If you use an estimated amount on Form 8615, enter “Estimated” on the line next to the amount.

   When you get the correct information, file an amended return on Form 1040X, Amended U.S. Individual Income Tax Return.

  Instead of using estimates, you can get an automatic 6-month extension of time to file if, by the date your return is due, you file Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return. Extensions are discussed in chapter 1.

Step 1. Figuring the Child's Net Unearned Income (Form 8615, Part I)

The first step in figuring a child's tax using Form 8615 is to figure the child's net unearned income. To do that, use Form 8615, Part I.

Line 1 (unearned income).   If the child had no earned income, enter on this line the adjusted gross income shown on the child's return. Adjusted gross income is shown on Form 1040, line 38, or Form 1040A, line 22. Form 1040EZ cannot be used if Form 8615 must be filed.

  If the child had earned income, figure the amount to enter on Form 8615, line 1, by using the worksheet in the instructions for the form.

  However, if the child has:
  • excluded any foreign earned income,

  • deducted either a loss from self-employment, or

  • deducted a net operating loss from another year,

then use the Alternate Worksheet for Form 8615, Line 1, in Publication 929 to figure the amount to enter on Form 8615, line 1.

Unearned income defined.   Unearned income is generally all income other than salaries, wages, and other amounts received as pay for work actually done. It includes taxable interest, dividends (including capital gain distributions), capital gains, unemployment compensation, the taxable part of social security and pension payments, and certain distributions from trusts. Unearned income includes amounts produced by assets the child obtained with earned income (such as interest on a savings account into which the child deposited wages).

Nontaxable income.   For this purpose, unearned income includes only amounts the child must include in total income. Nontaxable unearned income, such as tax-exempt interest and the nontaxable part of social security and pension payments, is not included.

Income from property received as a gift.   A child's unearned income includes all income produced by property belonging to the child. This is true even if the property was transferred to the child, regardless of when the property was transferred or purchased or who transferred it.

  A child's unearned income includes income produced by property given as a gift to the child. This includes gifts to the child from grandparents or any other person and gifts made under the Uniform Gift to Minors Act.

Example.

Amanda Black, age 13, received the following income.

  • Dividends — $800

  • Wages — $2,100

  • Taxable interest — $1,200

  • Tax-exempt interest — $100

  • Net capital gains — $100

The dividends were qualified dividends on stock given to her by her grandparents.

Amanda's unearned income is $2,100. This is the total of the dividends ($800), taxable interest ($1,200), and net capital gains ($100). Her wages are earned (not unearned) income because they are received for work actually done. Her tax-exempt interest is not included because it is nontaxable.

Trust income.   If a child is the beneficiary of a trust, distributions of taxable interest, dividends, capital gains, and other unearned income from the trust are unearned income to the child.

  However, for purposes of completing Form 8615, a taxable distribution from a qualified disability trust is considered earned income, not unearned income.

Line 2 (deductions).   If the child does not itemize deductions on Schedule A (Form 1040), enter $2,000 on line 2.

  If the child does itemize deductions, enter on line 2 the larger of:
  1. $1,000 plus the portion of the child's itemized deductions on Schedule A (Form 1040), line 29, that are directly connected with the production of unearned income entered on line 1, or

  2. $2,000.

Directly connected.   Itemized deductions are directly connected with the production of unearned income if they are for expenses paid to produce or collect taxable income or to manage, conserve, or maintain property held for producing income. These expenses include custodian fees and service charges, service fees to collect taxable interest and dividends, and certain investment counsel fees.

  These expenses are added to certain other miscellaneous itemized deductions on Schedule A (Form 1040). Only the amount greater than 2% of the child's adjusted gross income can be deducted. See chapter 28 for more information.

Example 1.

Roger, age 12, has unearned income of $8,000, no other income, no adjustments to income, and itemized deductions of $300 (net of the 2% limit) that are directly connected with his unearned income. His adjusted gross income is $8,000, which is entered on Form 1040, line 38, and on Form 8615, line 1. Roger enters $2,000 on line 2 because that is more than the total of $1,000 plus his directly connected itemized deductions of $300.

Example 2.

Eleanor, age 8, has unearned income of $16,000 and an early withdrawal penalty of $100. She has no other income. She has itemized deductions of $1,050 (net of the 2% limit) that are directly connected with the production of her unearned income. Her adjusted gross income, entered on line 1, is $15,900 ($16,000 − $100). The amount on line 2 is $2,050. This is the larger of:

  1. $1,000 plus the $1,050 of directly connected itemized deductions, or

  2. $2,000.

Line 3.   Subtract line 2 from line 1 and enter the result on this line. If zero or less, do not complete the rest of the form. However, you must still attach Form 8615 to the child's tax return. Figure the tax on the child's taxable income in the normal manner.

Line 4 (child's taxable income).   Enter on line 4 the child's taxable income from Form 1040, line 43, or Form 1040A, line 27.

  However, if the child files Form 2555 or 2555-EZ to claim the foreign earned income exclusion, housing exclusion, or housing deduction, see the Form 8615 instructions or Pub. 929.

Line 5 (net unearned income).   A child's net unearned income cannot be more than his or her taxable income. Enter on Form 8615, line 5, the smaller of line 3 or line 4. This is the child's net unearned income.

  If zero or less, do not complete the rest of the form. However, you must still attach Form 8615 to the child's tax return. Figure the tax on the child's taxable income in the normal manner.

Step 2. Figuring Tentative Tax at the Parent's Tax Rate (Form 8615, Part II)

The next step in completing Form 8615 is to figure a tentative tax on the child's net unearned income at the parent's tax rate. The tentative tax at the parent's tax rate is the difference between the tax on the parent's taxable income figured with the child's net unearned income (plus the net unearned income of any other child whose Form 8615 includes the tax return information of that parent) and the tax figured without it.

When figuring the tentative tax at the parent's tax rate on Form 8615, do not refigure any of the exclusions, deductions, or credits on the parent's return because of the child's net unearned income. For example, do not refigure the medical expense deduction.

Figure the tentative tax on Form 8615, lines 6 through 13.

Note.

If the child or parent has any capital gains or losses, get Publication 929 for help in completing Form 8615, Part II.

Line 6 (parent's taxable income).   Enter on line 6 the parent's taxable income from Form 1040, line 43, Form 1040A, line 27, or Form 1040EZ, line 6.

  If the Foreign Earned Income Tax Worksheet (in the Form 1040 instructions) was used to figure the parent's tax, enter the amount from line 3 of that worksheet instead of the parent's taxable income.

Line 7 (net unearned income of other children).   If the tax return information of the parent is also used on any other child's Form 8615, enter on line 7 the total of the amounts from line 5 of all the other children's Forms 8615. Do not include the amount from line 5 of the Form 8615 being completed.

Example.

Paul and Jane Persimmon have three children, Sharon, Jerry, and Mike, who must attach Form 8615 to their tax returns. The children's net unearned income amounts on line 5 of their Forms 8615 are:

  • Sharon — $800

  • Jerry — $600

  • Mike — $1,000

Line 7 of Sharon's Form 8615 will show $1,600, the total of the amounts on line 5 of Jerry's and Mike's Forms 8615.

Line 7 of Jerry's Form 8615 will show $1,800 ($800 + $1,000).

Line 7 of Mike's Form 8615 will show $1,400 ($800 + $600).

Other children's information not available.   If the net unearned income of the other children is not available when the return is due, either file the return using estimates or get an extension of time to file. See Parent's return information not known timely , earlier.

Line 11 (tentative tax).   Subtract line 10 from line 9 and enter the result on this line. This is the tentative tax.

  If line 7 is blank, skip lines 12a and 12b and enter the amount from line 11 on line 13. Also skip the discussion for lines 12a and 12b that follows.

Lines 12a and 12b (dividing the tentative tax).   If an amount is entered on line 7, divide the tentative tax shown on line 11 among the children according to each child's share of the total net unearned income. This is done on lines 12a, 12b, and 13. Add the amount on line 7 to the amount on line 5 and enter the total on line 12a. Divide the amount on line 5 by the amount on line 12a and enter the result, as a decimal, on line 12b.

Example.

In the earlier example under Line 7 (net unearned income of other children), Sharon's Form 8615 shows $1,600 on line 7. The amount entered on line 12a is $2,400, the total of the amounts on lines 5 and 7 ($800 + $1,600). The decimal on line 12b is  
.333, figured as follows and rounded to three places.

  $800 = .333  
  $2,400  

Step 3. Figuring the Child's Tax (Form 8615, Part III)

The final step in figuring a child's tax using Form 8615 is to determine the larger of:

  1. The total of:

    1. The child's share of the tentative tax based on the parent's tax rate, plus

    2. The tax on the child's taxable income in excess of net unearned income, figured at the child's tax rate, or

  2. The tax on the child's taxable income, figured at the child's tax rate.

This is the child's tax. It is figured on Form 8615, lines 14 through 18.

Alternative minimum tax.   A child may be subject to alternative minimum tax (AMT) if he or she has certain items given preferential treatment under the tax law. See Alternative Minimum Tax (AMT) in chapter 30.

   For more information on who is liable for AMT and how to figure it, see Form 6251, Alternative Minimum Tax—Individuals. For information on special limits that apply to a child who files Form 6251, see Certain Children Under Age 24 in the Instructions for Form 6251.


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