If your child has investment income, you may be able to elect to include the income on your return instead of filing a return for the child.   If you make this election, the federal income tax on your child’s income may be at a higher rate and there may be certain deductions that are limited or you cannot take.

For this purpose, a child includes a legally adopted children and stepchildren, and the rules apply whether or not the child is a dependent.

The two main rules that may affect the tax on investment income of certain children are as follows:

1. If your child’s interest and dividend income (including capital gains distributions) total less than $9,500, you may be able to choose to include that income on your return rather than file a return for your child.
2. If your child’s interest, dividends, and other investment income total more than $1,900, part of that income may be taxed at your rate instead of the child’s tax rate.

Parent’ Election to Report Child’s Interest and Dividends.  You may be able to make the election to include your child’s interest and dividend income (including capital gain distributions) on your tax return if all the following conditions are met:

• Your child was under age 19 (or under age 24 if a full-time student) at the end of the year
• Your child had income only from interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends)
• The child’s gross income was less than $9,500
• The child is required to file a return unless you make this election
• The child does not file a joint return for the year
• No estimated tax payment was made for the year, and no overpayment from the previous year (or from any amended returns) was applied to this year under your child’s name and social security number
• No federal income tax was taken out of your child’s income under the backup withholding rules
• You are the parent whose return must be used when applying special tax rules for children

Rate May Be Higher.  If you elect to include your child’s investment income on your return, you may pay up to $95 more tax than had you filed a separate return for your child.  This is because the tax rate on your child’s income between $950 and $1,900 is 10%, while if you file a separate return the tax rate may be as low as 0% because of the preferential tax rates for qualified dividends and capital gain distributions.

Deductions You Cannot Take.  By making this election to include your child’s income, there are deductions that you cannot take that the child would be entitled to on his or her own return.  These deductions include: the additional standard deduction if the child is blind; the deduction for a penalty on an early withdrawals of your child’s savings, and; itemized deductions, such as your child’s investment expenses or charitable contributions.

Reduced Deductions or Credits.  If you make the election to include your child’s income, your increased adjusted gross income may reduce certain deductions or credits on your return, including:

• Deductions for contributions to a traditional IRA
• Deduction for student loan interest
• Certain itemized deductions
• Credit for child and dependent care expenses
• Child tax credit
• Education tax credits

Penalty for Underpayment of Estimated Tax.  You may be subject to a penalty if you make this election, but did not have enough tax withheld or pay enough estimated tax to cover the tax you owe. If you plan to make this election, you may need to increase your federal income tax withholding or your estimated payments to avoid the penalty.

Figuring Child’s Income and Additional Tax.  Use Form 8814, Parent’s Election to Report Child’s Interest and Dividends, to figure your child’s interest and dividend income and the related tax.

Tax for Certain Children Who Have Investment Income of More Than $1,900.  If your child’s interest, dividends, and other investment income total more than $1,900, part of that income may be taxed at your rate if you elect to include their income on your return.

Your tax preparer can provide you with more information regarding income tax returns for children.  StrataTax, a San Diego consulting and tax services firm, is available year-round to assist you with income tax preparation and tax planning.  Call us at (858) 225-7720 to setup your free initial consultation or visit us at www.StrataTax.com for more information.

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