Tax Rules for Children with Investment Income

If your children are fortunate enough to have investment accounts, they may be required to file a tax return to declare the income they receive – interest, dividends, capital gain distributions and income from a trust. Or if you meet certain requirements, you may elect to declare the child’s income on your income tax return.

If the investment income is less than $9,500 for the year, you may be able to claim the income and pay the tax on your own tax return if the following conditions are met:

1. The dependent must be your child under age 19 or age 24 if a full-time student at the end of the year in question. A child born on Jan. 1 will be considered to have been born on Dec. 31 for this purpose. So if, for example, your child turned 19 on Jan. 1, 2013, she will be considered age 19 as of Dec. 31, 2012.
2. The income must be strictly investment income and not include W2s wages or other forms of earned income.
3. There can’t have been any withholding under the child’s Social Security number.
4. There can’t have been any estimated tax payments made under the child’s Social Security number.
5. The child is not filing a joint income tax return.
6. You are the parent whose return must be used when applying the special tax rules for children. This rule applies in cases where the parents are divorced, married filing separately, or were never married.

To make the election to include your child’s investment income on your tax return, include Form 8814 when filing your income tax return. Note that to include this form you must file Form 1040--you cannot use Forms 1040-A or 1040-EZ.

If you include the child’s investment income on your tax return, you cannot take the additional standard deduction for a blind child, the deduction for a penalty on an early withdrawal of your child's savings, or itemized deductions (such as your child's investment expenses or charitable contributions).

On Form 8814 Part II, calculate the tax on 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 on the first $1,900 of investment income is the smaller of 10% x (your child's gross income − $950 or $95). Include the amount from line 15 of all your Forms 8814 in the total on Form 1040, line 44, or Form 1040NR, line 42. Check box a on Form 1040, line 44, or Form 1040NR, line 42. The amount of investment income that exceeds the $1,900 base amount will show on line 21 of your Form 1040 and be included with the remainder of the parent’s income.

If your child’s investment income exceeds $9,500 you must file a separate tax return for the child and include Form 8615. If you claim your child as a dependent on your own tax return, don’t check box 6(a) on Form 1040-A or Form 1040 as the child is not allowed to claim an exemption.

According to the IRS, 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 $1,900;
2. The child is required to file a return for 2012;
3. The child eithe; Was under age 18 at the end of the year 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 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. Was under age 18 at the end of the year
5. 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
6. 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.
7. At least one of the child's parents was alive at the end of 2012;
8. The child does not file a joint return for 2012.

The rules are extremely complicated and involve so many scenarios that I suggest you read IRS Publication 929 for more information.