How Do You Determine When A Child Becomes A Separate Taxpayer

Most of the time, children are considered to be an extension of their parents when it comes to a legal application until the age of majority.  Therefore, many taxpayers are surprised to learn their child is a separate taxpayer, even as a minor.  If your child has enough income, he or she has an obligation to file a return and pay the tax.  In some cases, you may include their income on your tax return; in others, they’ll have to file their own tax return, or you will have to file a separate return on their behalf.  Whether this is required depends on both the amount and source of the minor’s income.

The first thing to look at is their earned income.  Earned income is defined in general as taxable employee pay, long term disability benefits, and self-employment net income, as well as other less common sources.  A minor who may be claimed as a dependent must file a return once their income exceeds their standard deduction.  Starting in 2018, the standard deduction for a dependent child is the total earned income plus $350, up to a maximum of $12,000.  Thus, a child can earn up to $12,000 without paying income tax.

The second thing reviewed is unearned income.  While there are several items that fall in this category, the most common to minor children are interest and dividends.  If your child’s income is above this year’s level, he or she must file; below that point, he or she isn’t required to file a tax return.  If the child has both earned and unearned income, both amounts must be added together to determine if the total income triggers the mandatory filing requirement.  If your child’s income is below the minimum threshold but owes Social Security or Medicare taxes on his or her coffee hour tips, a return must be filed.  Additionally, even if your child does not meet any of the filing requirements discussed, he or she should file a tax return if (1) income tax was withheld from his or her income, or (2) he or she qualifies for the earned income credit, and/or any additional credits.  See the tax return instructions and talk to your accountant to find out who qualifies for these credits.  By filing a return, your child may get a refund.

Prior to 2018, if your child needed to file a return based solely on unearned income, the IRS allowed for you to claim the income on your return given certain restrictions, and the income was taxed at the parents’ rate.  This is known as the “kiddie tax” and prevented parents from transferring income-producing assets to their children to pay lower tax rates.  However, the Tax Cuts and Jobs Act of 2017 greatly modified this alternative for tax years 2018 through 2025 by changing the rates for the kiddie tax by using the estate and trust tax brackets.  These are taxed at the highest rate of thirty-seven percent for 2018, which, as an example,  is not reached by a married filing joint couple until their income tops $600,000.  If you determine to claim the child’s income on your own return, you will report this income on Form 8814 and attach it to your return.  If you make this election, you still get the benefit of the child’s standard deduction.

Some benefits that might be claimed on a child’s separate income tax return are not available if you report the child’s income on your tax return.  For example –  your child forfeits interest from making an early withdrawal from a savings account,  itemized deductions, including state income tax and charitable contributions that add up to tax savings from those itemized deductions would potentially be available,  and if your child is blind, a larger standard deduction is available on a separate tax return.  In addition, the tax on the child’s income may be somewhat higher if the child received capital gains distributions.  You get the benefit of the capital gains rate on any portion of the child’s income taxed at your rate but lose the benefit on any portion taxed at the child’s rate.

Ultimately,  the responsibility for filing your child’s tax return rests with your child if he or she is capable of doing so. If he or she is not old enough to understand how to prepare a tax return, then it becomes your responsibility to file it for them or to include their income on your return.  Your child doesn’t have to be of legal age to sign an income tax return.  Any child old enough to sign his or her name can do this.  There’s a catch, though –  If you sign the return and the IRS ends up having questions, they can deal directly with you.  If your child signs the return, there will be limits on what they can discuss with you and what actions you can take to resolve any issues, unless you have a valid power of attorney to act on your child’s behalf.  There is a middle ground.  Your child can sign the return but show you as the “third party designee” using a space provided for this purpose near the signature line of the return.  That gives you limited authority to deal with the IRS on the tax return without a power of attorney.

Paying the tax (and interest and penalties, if applicable) is the child’s obligation.  You can pay for the income tax from your own money, but in general, the IRS considers this a gift to your child.  So long as your child remains dependent, there will be tax implications for you.  Many families review various tax return preparations and results to determine which filing combination will result in the best tax benefits for everyone.  Always consult a tax professional if your situation is complex.