Whichever method you
choose, the first $1,000 of the child's investment income will be tax-free
and the next $1,000 will be taxed at the child's 5% or 10% tax rate
depending on earned income.
Additional income is taxed at the parents' rate, which may be a lot higher
However, the "kiddie tax" that results from reporting the
child's income on a parent's return can indirectly result in a higher
family tax burden.
The reason is that if
your child's income exceeds $2,000, any excess will increase your
"adjusted gross income," which in turn can reduce some of your
tax benefits. The size of certain tax benefits is tied to your adjusted
gross income. Generally, the higher your income, the smaller your
Among the tax benefits at risk are write-offs for medical and
"miscellaneous" itemized expenses, Individual Retirement Account
deductions and the child-care credit. The list grows longer for
higher-income parents who are subject to automatic reductions in most
itemized deductions and a phaseout of personal exemptions as their income
On the other hand, reporting the child's income on a
parent's return can increase the amount of investment interest expense
that the parent can write off and raise the deductible ceiling on large
charitable contributions. But relatively few people will find those
advantages outweighing the disadvantages of including the child's income
on their own return.
Nevertheless, filing a separate return
for the child may not be the most economical option either. We know from
experience that it takes time for both the preparation and the internal
processing of an additional tax return in our office to prepare a special
return for your child. Rest assured, however that we do attempt to
make the best decision for our clients in each individual situation.