Ugh the Kiddie Tax.
basically if they have unearned income (interest and dividend) greater than $1700 then all bets are off.
I'm going to cheat - just easier to cut/paste from my service that i subscribe to. Rules are the same for 2006.
In general, a child's tax liability is computed the same as other taxpayers, with potential limits on the standard deduction and personal exemption.
However, children under age 18 at the end of 2006 may be subject to tax at the parent's top marginal rate. The child's tax liability is the greater of the tax computed using the child's rate or the sum of:
(1) the tax computed on the child's taxable income less the child's net unearned income; and
(2) the child's share of the "allocable parental tax."
Two special rules apply to the tax on certain investment income for children under age 18:
(1) if the child's interest, dividends, and other investment income totals more than $1,700, part of the income may be taxed at the parent's tax rate; and
(2) the child's parent may be able to include the interest, dividend, and capital gain income on the parent's return rather than filing a return for the child.
These rules do not apply if the child is required to file a return or if both parents are deceased as of the end of the tax year.
Net Unearned Income A child's net unearned income is the excess of his AGI that is not earned income over the sum of:
(1) $850; plus
(2) the greater of $850 or the amount of the child's itemized deductions attributable to the child's unearned income.
Thus, for 2006, a child under age 18 must have net unearned income of at least $1,700 to be subject to the kiddie tax.
If this threshold is exceeded, Form 8615, Tax for Children Under Age 18 Who Have Investment Income of More Than $1,700, must be completed and attached to the child's return. Earned income includes wages, salaries, and other compensation for services. Income from property owned by the child is unearned income, regardless of whether the property was acquired by gift or from earned funds. Social security or pension payments are considered unearned income to the extent includible in the gross income of the child.
EXAMPLE: Billy is 16 years old in 2006 and receives $1,900 of interest and dividends during the year. His parents claim him as a dependent. He does not have any itemized deductions for the year. Billy's net unearned income is $200 ($1,900 of interest and dividends less $1,700).
Allocable Parental Tax The allocable parental tax is the additional amount of tax that would be calculated if the child's net unearned income were included in the parent's taxable income.
The tax is computed taking into account the phase-out of the personal exemptions; however, limitations of deductions based on AGI (such as medical expenses and casualty losses) are not further reduced.
In addition, if the parent's taxable income is later adjusted, the child's tax must also be recomputed.
EXAMPLE: Amanda is 17 and has gross income of $2,900 in 2006, which is all unearned. Her net unearned income is $1,200 ($2,900 less $1,700). Her taxable income is $2,050 ($2,900 less $850). Amanda's parents' highest marginal rate for 2006 is 28 percent. The tax is computed as follows:
Amanda's Tax
Taxable Income
$2,050
Tax at Amanda's Rate (10%)
$205
Allocable Parental Tax
Taxable Income
$2,050
Less net unearned income
$1,200
$850
Amanda's tax (850 x 10%)
$85
Parents' tax (1,200 x 28%)
$336
Total Allocable Parental Tax
$421
Amanda's tax is the greater of her individual tax ($205) or the allocable parental tax ($421), or $421.
