If your kids discovered the joys of capitalism this year, raking in the dough from paper routes or pizza delivery, or receiving stocks or bonds instead of toys for their birthdays, they may also get to experience the joy of taxes this April. You may be surprised to find that, as dependents, your children have different rules for when to file taxes, and on what income, than you do.
When you pay your own taxes, you’re entitled to a personal exemption of $3,950 for tax year 2014. Therefore, the first $3,950 of your income isn’t taxed. When you claim your child as a dependent, you get to deduct their personal exemption on your taxes, which means your child doesn’t get to use it on theirs.
You may be tempted to skip claiming the exemption for your dependents in hopes that they will then receive the personal exemption themselves. On the contrary, whether you claim them or not, a person who qualifies as a dependent will not receive the personal exemption. As a result, if you choose not claim your dependent, no one will receive it.
Luckily, while dependents don’t get to take their own exemption, they do get a very nice standard deduction. If your child had a job that withheld taxes, it’s usually worth the time to file their taxes because he or she is likely to get most (or all) of the withheld money back.
Here are the key points you need to know when helping your child file their taxes.
Tax Filing Guidelines for Dependents
You can still claim your child as a dependent even after they reach 18, as long as they meet other rules for dependency. Because of this, the rules below apply to anyone who is claimed as someone else’s dependent, is under age 65, and is not blind. Keep in mind that there’s no lower limit on age, so if your newborn was gifted dividend-paying stocks or mutual funds, you might have to start doing this sooner than you think.
The first step in the process of helping your children file their taxes is figuring out what they’re eligible for. To do this, you need any W-2 tax forms (or other paperwork they should have received in January) that detail their taxable income.
Once you have this paperwork in hand, consider the following:
1. Earned vs. Unearned Income
The IRS defines income using two categories:
- Earned Income. This refers to wages, tips, salary, professional fees, or commission earned by doing actual work.
- Unearned Income. Any other income that wasn’t directly worked for – such as dividends, interest, or capital gains (such as from selling stock) – is considered unearned income. If the child has a trust fund, distributions from that are considered unearned income – unless the child has a disability trust, in which case distributions are considered earned income.
Knowing where your child’s earnings fall is critical to determining whether they are required to file.
2. Income Guidelines
Now that you know how your child’s income is defined by the IRS, you can figure out their legal obligations. As of tax year 2014, your child must file a tax return if any of these situations apply:
- His or her earned income is more than $6,200
- His or her unearned income is more than $1,000
- His or her earned income plus unearned income is more than the greater of: $1,000, or earned income up to $5,850 plus $350
So, if he or she had up to $5,750 of earned income and $200 of unearned income, it is not necessary to file a tax return. Another less obvious example would be if he or she had $300 of earned income and $500 of unearned income. It doesn’t seem like much, but it would still be necessary to file a tax return, because $300 + $500 + $350 = $1,150, which is larger than $1,000.
The idea here is that if your child earned a decent amount of money, the bar for being taxed is quite a bit higher than if all they did was cash dividend checks.
3. Is It Worth It?
The fact that your children don’t have to file taxes doesn’t mean it wouldn’t be beneficial for them to do so. If they have jobs that withhold federal taxes and they get a W-2 at the end of the year, chances are that they’ll get at least some of that money back.
If it still seems like too much of a hassle, think about this: If you don’t file taxes, you don’t get a tax refund. They could also qualify for education tax deductions and credits if they are putting themselves through college or otherwise taking classes.
4. Special Circumstances
There are a few specific circumstances in which your child must file taxes even if they don’t have a lot of income. These are the ones that they’re most likely to run into:
- They owe any Social Security or Medicare tax (such as if they are reporting tip income that they received in cash)
- They received any advance Earned Income Credit
- They had $108.28 or more of wages from a church or other religious organization that doesn’t withhold Social Security or Medicare
- They had $400 or more in profit from self-employment
If you’ve crunched the numbers and determined that it would be in your child’s best interest to file, the next step is to figure out how much they can take for a standard deduction.
Standard Deduction for Dependents
While dependents don’t get to take their personal exemption (since their parent or provider takes it), they do get to take a standard or itemized deduction. The standard deduction a dependent can take is the larger of:
- The individual’s earned income for the year plus $350 (but not more than the regular standard deduction amount, $6,200 for 2014)
This big deduction means that most children won’t have to pay taxes. In other words, if your child had federal taxes withheld and earned less than the regular standard deduction amount, they’ll get it all back. Children are also able to itemize their deductions for charitable donations and other items using Schedule A just like adults, but for most, it’s easier and smarter to use the standard deduction.
Who Can File the Return?
Interestingly, there are no official age guidelines defining who can sign and file a tax return. If your children are able to understand the instructions and fill out the return, then by all means, have them do so. Since they have to use the same 1040 IRS tax form (or the 1040A or 1040EZ, if you prefer) that you would use for yourself, it will be easy for you to assist them. Children can also itemize their deductions using Schedule A. This can be an excellent opportunity to teach your kids about money management and the process of filing taxes.
If they’re old enough, children can be responsible for filing the return themselves. Just remember, they will be responsible for any penalties that might occur. This legal liability could become a problem if the IRS finds problems with the return. They can refuse to divulge information or discuss any problems with you if your name is not signed, or at least noted somewhere on the form.
Fortunately, if a child is too young to handle this kind of responsibility, the parent or guardian is expected to complete the form for them. If your child isn’t old enough to sign their own return, you should complete it, sign their name for them, and add “By (your name), parent (or guardian) for minor child.”
Issues and Audits
Would the IRS really audit a child? Absolutely. Audits are just as blind to age as the filing process itself.
Don’t worry that your newborn will get hauled into court, though. If you signed the return for them, a parent or guardian is allowed to deal with the IRS if any issues come up, or if the child’s tax return is audited.
As noted above, if your child signs the return by him- or herself, it can get a little sticky. The parent can provide information to the IRS, but can’t do anything else with the return – that is, unless, your child wrote you in as a third-party designee who has permission to discuss the return with the IRS. This designation doesn’t allow the parent to receive the child’s refund or agree to any further tax liability. It is a safe way for parents to remain involved while still respecting the child’s freedom to file on his or her own.
That said, if you receive a notice from the IRS about your child’s tax return, you should immediately contact the IRS to disclose that the return is that of a minor child. The IRS will let you know how to proceed.
Filing Your Child’s Unearned Income on Your Return
If your child received $10,000 or less in interest and dividends during the year, you might be able to include his or her income on your own tax return instead of filing one separately. This can be a real time-saver for families in which the children own stocks or bonds that generate income. However, if you make this election, you may end up owing more tax on your child’s income. This is because you’ll lose the preferential tax treatment of capital gains distributions and qualified distributions if you report your child’s investment income on your return.
Keep in mind:
- This only applies if the child only has unearned income. Earned income cannot be filed on your return.
- The child has to be 19 or younger (or 24 or younger if he or she a full-time student).
- If the unearned income is $2,000 or more, you must file an additional form (Form 8615), and since children have a lower tax rate on some items, you might end up paying more in taxes.
- If their unearned income is between $1,000 and $12,000, you’re almost always financially better off filing a separate tax return for your child.
If you find that your child’s unearned income is more than $2,000, some of it will be taxed at your marginal tax rate whether or not you put their income on your tax return. This is definitely a situation where you’ll want to consult an accountant, especially if your child will be receiving unearned income for a few years in a row (such as if they own some dividend-bearing stock), so that you can do it on your own next year. For more details, check out Publication 929, Tax Rules for Children and Dependents.
Filing taxes can be an important financial milestone for your child. If they are old enough to understand, involve them in the process, and start them off on the right foot toward becoming a responsible, tax-paying citizen. They’ll enjoy the refund check now, and they’ll later appreciate the early introduction to this complex process.