Don’t Forget Your Child’s Investment Income this Tax Season

It’s common for children to receive financial contributions from parents, grandparents and other relatives to help secure a child’s financial future by funding investment accounts for them—but they come with tax implications that must be reported come April 15.

These accounts are normally in the child’s name and Social Security number, but held in trust with a parent or guardian. At year end, a 1099 is issued to declare the dividends, interest and capital gains earned during the year. Other unearned income may be generated by a trust.

This creates a tax obligation and a tax return must be filed. However, if the total interest and dividend income is less than $10,000 in 2013, parents can elect to report the income on their own tax return using IRS Form 8814 rather than filing a separate income tax return for the child. Other qualifiers for using this form include:

  1. The child must be under age 19 (or under age 24 if a full time student) at the end of the year;
  2. The child must not be using married filing joint status;
  3. And the child must not have paid estimated tax payments or had federal income tax withheld on the earnings.

There are qualifiers for using Form 8814 for the parents as well:

  1. You must file a joint return with the child’s other parent or;
  2. If married filing separately, the parent with the higher taxable income must claim the child’s investment income or;
  3. If unmarried or separated from the child’s other parent by a divorce or separate maintenance agreement, the child must have lived with you for most of the year or;
  4.  If you have remarried, filing a joint return with your new spouse and you were the custodial parent.

By not filing a separate tax return for your child, you may miss out on some benefits, including: the ability to write off the child’s investment expenses, fund management or advisory fees or the early withdrawal penalty on a child’s savings account.

You may also end up paying more tax by including the child’s income on your tax return if the child has tax advantaged qualified dividends or capital gain distributions. This is simply because the child’s tax rate on income between $1,000 and $2,000 is 10% if you make the election to file Form 8814 with your own tax return.

As you are undoubtedly aware, the IRS has been scrutinizing offshore accounts. It’s possible that your child’s monies may be invested in foreign banks or trusts. If so, make sure you complete Schedule B of Form 1040, Part III and file it with your tax return. You may also be required to file IRS Form 8938 to declare foreign financial assets.

April 15 Deadline Tax Tip:Please know that if you owe the IRS for 2013, filing an extension does not grant you an extension of time to pay. It only grants an extension of time to file your tax return until October 15, 2014. The IRS expects payment in full on April 15. It’s usually less expensive to borrow off a high interest credit card to meet your tax obligation than it is to set up an installment agreement with the IRS.