Tip of the Week: Children and Investing (4/19/99)

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	Children and Investing Financial Tip of the Week by Deloitte & Touche OnLine April 19, 1999

Different rules apply to taxing investment income of children.

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Children are taxpayers in their own right for any income they earn and for their investment income. Once they reach the age of 14, their separate tax status may permit a significant amount of investment income to be taxed at rates that may be significantly below the rates that apply to their parents.

Special rules apply for taxation of children’s investment income while they are under age 14. The general structure of taxation for children who are 13 years old and younger (at the end of the tax year) and have a parent living at the end of the tax year can be summarized as follows:

A dependent child is allowed to receive an inflation-adjusted amount of unearned income ($700 in 1998) without paying any tax, as long as the child does not have any earned income.
The child’s taxable earned income and an amount of unearned income equal to the applicable standard deduction ($700 in 1998) are taxed to the child at the child’s marginal tax rate.
The balance of unearned income is taxed to the child as if it were the parents’ income. The tax is calculated by determining what the parents’ tax would be if the child’s net unearned income were added to the parents’ taxable income. As a result, some of the child’s income may be subject to tax at rates as high as 39.6 percent.

If the child’s parents do not file a joint return, additional rules determine which parent’s tax rate applies. If the parents are divorced, it is generally the custodial parent’s rate that is used. For 1998, for instance, parents were allowed to elect to include their child’s income on their return if the child’s income is between $700 and $7,000 and consists solely of interest and dividend income. If the parents make this election, the child is treated as having no gross income and therefore is not required to file a return. Beginning in the tax year in which the child reaches age 14, these restrictive provisions no longer apply.

For more tax tips on planning your finances throughout the year, see our Tax Planning Guide.