Uncle Sam Has a Special Place in His Heart for Kids Who Owe
Thanks to 1995’s fabulous stock market performance, being a kid is likely to be a bit more taxing than usual.
That’s because even a fairly modest college fund, invested wisely, could have pushed a youth over the $650 filing threshold last year simply because the market did so well.
Indeed, some kids will even find themselves paying taxes at their parents’ rates for 1995.
What do youths--even toddlers--need to know about filing a federal tax return? Here’s a look.
Q. When do I have to file a federal tax return?
A. Children under the age of 14 are required to file if the combination of their income from jobs and investments exceeds $650. However, if the child has no investment income--only earnings from a job or jobs--they don’t need to file until their income tops $3,900, says Keith Kimball, an IRS spokesman in Los Angeles.
Q. What if I’m 14 or older?
A. As long as you are a dependent--that means somebody else pays more than half your living expenses--you are subject to the same filing requirements as younger children. However, your tax rate could be a little different.
Oddly enough, the younger child might have to pay more tax than you, if he or she earned a significant amount in interest and investment income. (That’s to ensure the child’s parents don’t cheat by shifting their income to the child to get the benefit of a lower tax rate.)
Once you are on your own and can no longer be legally claimed as a dependent on another person’s return, you fall under the same rules as an adult. Namely, if you are single, you have to file once your gross income exceeds $6,400; if you’re married, you would have to file once your joint income topped $11,550.
Q. Does it make any sense to file if I don’t have to?
A. Parents may want to file even if they don’t have to simply because they could be eligible for a refundable tax break, called the Earned Income Tax Credit. It allows individuals with less than $26,673 in income to claim up to $3,110 in tax credits. These credits can be refunded even if the individual paid no federal income tax in 1995. A more modest tax break of up to $314 is available to single filers with no dependents who earn less than $9,230 a year.
Q. How is a little kid expected to file a tax return?
A. The child isn’t necessarily expected to file a return--particularly since taxes are sometimes owed by children who are too young to write. In these instances, a parent or guardian is expected to file the return on the child’s behalf.
Q. How much tax do children pay on their income?
A. That depends on the amount of income they earn and how they earn it. However, since most minors who owe taxes do so because of college funds that pay investment income, we’ll look at how that works.
The first $650 of income is not taxed at all. The next $650 is taxed at a 15% rate. However, for a child under the age of 14, any unearned income over $1,300 ($650 plus $650), is taxed at the parent’s highest marginal tax rate.
Let’s say you are 10 years old and have a $5,000 college fund that’s invested in stock market mutual funds. In 1995, you earned a tidy 30% on your money, or $1,500. Your mom and dad are in a 36% tax bracket. You pay just $97.50 in federal income taxes on the first $1,300 of earnings. But the final $300 gets hit with a whopping $108 tax because of your parents’ high bracket. In the end you pay a total of $205.50.
Capital gains would be taxed at the marginal rate but are capped at 28%.
Q. Do I have to file a 1040 just like my parents?
A. Actually, you have several choices. The easiest thing to do is file with your parents by filling out Form 8814. However, for reasons inexplicable to anyone but government officials, those who file this form get smaller deductions and must cope with a host of other ills--such as phase-outs for itemized deductions and personal exemptions--that nearly assure you’ll pay more tax, says Nancy Anderson, manager of special projects at H&R; Block in Kansas City, Mo.
The other option is to file one of the 1040 forms--the lengthy 1040, the shorter 1040A or the simplistic 1040EZ--plus Form 8615, which allows minors to calculate their tax at preferential rates.
Q. Does it matter which of those forms I use?
A. If you have more than $400 in investment income, you can’t file the 1040EZ. Why not? Apparently, when the tax forms were designed the IRS decided that someone with more than $400 in investment and interest income is more likely to have a more complicated tax situation. In that case, your choices boil down to the 1040A or the 1040. While the 1040 is longer, you only have to fill out the lines that apply to you, so it doesn’t really matter which form you choose.
Q. Is it hard to file a tax return?
A. Not usually. If you can read, add, subtract, multiply and divide, you shouldn’t have any trouble at all. It’s just a matter of reading and following the instructions. But if you’ve got a lot of money invested and your parents are rich, it can get complicated because some byzantine tax rules kick in. At that point, you should figure on getting your tax return prepared for you. The good news is that tax counseling and preparation fees are tax deductible--even for kids.
