What it means
Many people assume a child with a small income never has to think about tax. Publication 929 shows that this is only partly true, because a dependent child can have a filing obligation and, in some cases, a tax bill, depending on how much they earn and what kind of income it is.
The publication separates earned income, such as wages from a part-time job, from unearned income, such as interest, dividends and gains on investments. Each type is treated differently, and the dependent's standard deduction is limited in a way that depends on the mix.
The thresholds are set by the tax authority and change over time, so the current edition should always be checked. The most famous feature is the so-called kiddie tax.
When a child's unearned income rises above a set level, the excess can be taxed at the parents' marginal rate (the rate on their last slice of income) rather than the child's lower rate. This stops families from shifting large investment portfolios into a child's name purely to cut the tax bill.
The publication also explains the choice some parents have to report a child's investment income on their own return instead of filing a separate one for the child. That can save paperwork, but it can also change what the parents owe, so it is a decision rather than a formality.
For a business owner, the relevance is practical. Gifting shares to a child, paying a child for genuine work in the family firm, or setting up a custodial account all create income that falls under these rules.
Treat the publication as the starting point and bring in a tax adviser for anything involving large amounts.
In practice
Real-world examples.
Example
A family that runs a bakery pays their 16-year-old son to work weekends in the shop, with a proper timesheet and a rate in line with what other staff are paid. His wages are earned income, and Publication 929 helps the parents see whether he must file a return of his own. The business also records the wages as a genuine deductible expense.
Example
A software engineer gives her 10-year-old daughter a portfolio of shares that pays regular dividends. Reading Publication 929, she finds that once the dividends pass the stated threshold, the excess is taxed at the parents' rate under the kiddie tax. She decides the shares are still a sensible long-term gift but stops expecting a large tax saving.
Example
A grandparent places a modest amount in a custodial account for a grandchild at university. The student's interest income is small and falls below the filing threshold, so Publication 929 tells the family that no separate return is needed in that year. They keep the paperwork anyway in case the income grows.
Case study
Seen in the real world.
Marlowe and Pike Logistics is an illustrative, fictional family-owned trucking firm. The founders wanted to start transferring ownership to their two teenage children, so they gifted each child a small block of shares. The shares paid an annual dividend, and nobody had thought about what that dividend would mean for the children's tax position.
At year end their bookkeeper spotted the income and checked Publication 929. She found that the dividends exceeded the level at which the kiddie tax applies, so part of the income would be taxed at the parents' rate. The family had a choice between filing returns for the children or, where eligible, including the income on the parents' return.
They worked through the alternatives with their accountant and decided to file separately for the older child, who also had summer wages, and to include the younger child's income on the parents' return. The illustrative lesson is that gifting an income-producing asset is never tax-neutral, and the publication is the quickest way to see why.
Watch out
Common mistakes.
- Assuming a child with a small income never has to file, when the answer depends on the type and amount of income and on whether they can be claimed as a dependent.
- Believing that putting investments in a child's name automatically moves the tax to the child's lower rate, when the kiddie tax can pull the excess back to the parents' rate.
- Treating payments to a child as a tax shelter without real work being done, when the pay must reflect genuine services at a reasonable rate.
Questions
People also ask.
What counts as unearned income?
Interest, dividends, capital gains and similar income from investments, as distinct from wages or self-employment earnings.
Can a parent report a child's income on the parent's return?
In some situations yes, and Publication 929 sets out the conditions, though it is worth comparing the result with filing separately.
Does the publication change every year?
It is updated regularly to reflect new thresholds and rules, so always use the edition that matches the tax year you are dealing with.
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