Does my child need to file taxes?

Not as bizarre a question as you might think

Sometimes, your child’s financial situation can expand beyond lemonade stands, allowances, and birthday money from grandma. We’re not sending little Timmy to the coal mines anymore, but kids can still work and even own investments. That means income, and where there’s income, the IRS is guaranteed to get involved.

So yes, your kid might need to pay taxes. Here’s what you need to know.

The basics

• If your child’s interest, dividends, and other “unearned income” total more than $1,250, they need to file a tax return
• If their total (earned) income exceeds the standard deduction ($13,850 in 2023), they need to file a tax return
• If your child only has income from investments and dividends, and it’s less than $1,250, you (the parent) may just be able to attach it to your tax return
• But we recommend that they file their own separate return

Does my child need their own tax return?

Your child is making money, and the IRS wants their cut. How does this work, exactly?

If their income is below a certain threshold, you don’t have to worry. But if they do need to file, and they’re too young to handle it themselves, that’s your job.

When to file a separate return for your child

Depending on how much they made, and how they made it, your child may be required to file a tax return of their own.

• If your child makes more than the standard deduction in earned income ($13,850 in 2023), they need to file a tax return
• If your child received more than $1,250 in unearned income (like dividends), they need to file a tax return

And even when it’s not required, it’s still a good idea. They could get a refund!

When to attach your child’s income to your tax return

It may be simpler to attach your child’s income to your own tax return, if possible. If your child’s income is only from interest and dividends (no W-2 income allowed) and is under $10,500 you can attach it to your personal tax return using IRS Form 8814.

This may push you into a higher tax bracket, so keep that in mind.

Which is better?

Overall, we recommend that your child files a separate tax return. That way, the IRS has something on file for them for that year, which is a much more favorable look if there’s ever any questions about their money. It will also establish limits on how far back the IRS is permitted to look in the event of an audit.

The kiddie tax

Designed to prevent rich folks from dodging taxes by funneling wealth through their kids, the “Tax on a Child’s Investment and Other Unearned Income,” better known as the kiddie tax, applies special rules to a child’s unearned income. Specifically, it applies to dependent children under the age of 19 and full-time students between the ages of 19 and 23.

• The first $1,250 of a child’s unearned income is covered by a deduction and not taxed
• The next $1,250 is taxed at a higher rate
• All amounts over $2,500 are taxed at the parent’s marginal income tax rate

Remember, this applies specifically to unearned income, not any income earned from wages.

What is unearned income?

Differentiating between earned income and unearned income is important here.

First of all, no, the name “unearned” does not imply that the money isn’t deserved. It simply refers to passive income, such as interest and dividends or an inheritance. If you acquired the money through means other than working, it’s unearned income.

On the flip side, earned income refers to any money you get by working for someone else, working for yourself, or from a business that you own.

Tax rates are sometimes different for earned and unearned income, and the distinction has all kinds of other tax implications. Qualifying for the Earned Income Tax Credit (EITC) is a prime example.

Interest and dividends

Interest (from bank accounts, loans, etc) is taxed as ordinary income, meaning it’s just taxed at the same rate as a paycheck would be.

Dividends (income from investments) can be taxed as ordinary income or get a nicer tax rate.

Ordinary dividends, the most common kind, are taxed at ordinary rates, but qualified dividends – issued by a US corporation or qualified foreign corporation, owned for at least 60 days out of a 121 day period, and not from an excluded category like Real Estate Investment Trusts – are taxed at the more favorable capital gains tax rates.

Bottom line

If your child is making money, however it happens, there’s a solid chance they need to file a tax return. And even if their income is below the limits, it’s still a good idea to file. There are different rules for earned income and unearned income, and they change every year, so be sure to keep up to date.

As the parent, you can sometimes attach their income to your tax return, but it’s better to file their own separate return.

Sound complicated? Schedule a call with the tax experts at DiMercurio Advisors. We’ll do your whole family’s taxes.