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 face different rules concerning 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 $4,000 for tax year 2015. Therefore, the first $4,000 of your income isn’t taxed. When you claim your children as dependents, you get to deduct their personal exemption on your taxes, which means they don’t get to use it.
You may be thinking it makes sense to skip claiming the exemption for your dependents in hopes that they can then receive the personal exemption themselves. On the contrary, whether you claim them or not, a person who qualifies as a dependent does not receive the personal exemption. As a result, if you choose not claim your dependent, no one receives it.
Luckily, while dependents don’t get to take their own exemption, they do get a very nice standard deduction. While dependents aren’t always required to file a return, if your children had jobs that withheld taxes, it’s usually worth the time to file because they are likely to get most (or all) of the withheld money back.
Here are the key points you need to know when helping your children file taxes.
Tax Filing Guidelines for Dependents
You can still claim your children as dependents 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 (from selling stock, for example) – is considered unearned income. If a 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 children’s earnings fall is critical to determining whether they are required to file.
2. Income Guidelines
Now that you know how children’s income is defined by the IRS, you can figure out their legal obligations. As of tax year 2015, your children must file a tax return if any of these situations apply:
- Earned income is greater than $6,300
- Unearned income is greater than $1,050
- Earned income plus unearned income is more than the greater of: $1,050, or earned income (up to $5,950) plus $350
So, if a child had up to $5,750 of earned income and $200 of unearned income, it is not necessary to file a tax return. Another example would be if a child had $300 of earned income and $500 of unearned income. In this case, it is also not necessary to file a tax return because $300 + $500 = $800, which is less than $1,050. The idea here is that if your children 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?
Just because children may not have to file tax returns doesn’t mean it wouldn’t be beneficial for them to do so. If they have jobs that withhold federal taxes and get a W-2 at the end of the year, chances are they can 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. Your children 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 children must file taxes even if they don’t have a lot of income. These are the most common scenarios:
- Owe Social Security or Medicare tax (such as if children are reporting tip income that they received in cash)
- Received any advance Earned Income Credit
- Earned $108.28 or more of wages from a church or other religious organization that doesn’t withhold Social Security or Medicare
- Earned $400 or more in profit from self-employment
If you’ve crunched the numbers and determined that it would be in your children’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 parents or providers take it), they do get to take a standard or itemized deduction. The standard deduction a dependent can take is the larger of the following:
- The individual’s earned income for the year plus $350 (but not more than the regular standard deduction amount, $6,300 for 2015)
This big deduction means that most children won’t have to pay taxes. In other words, if your children 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 yourself, you should be able to assist them. This can be an excellent opportunity to teach your kids about money management and the process of filing taxes.
Just remember, children are responsible for any penalties that might occur. This legal liability could become a problem if the IRS finds issues with the return. The IRS can even refuse to divulge information or discuss any problems with you if your name is not signed or noted as a third-party designee on the form.
Fortunately, if children are too young to handle this kind of responsibility, their parent or guardian is expected to complete the form for them. If your child isn’t old enough to sign a tax return, you should complete the return, sign your child’s name, 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, 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 children sign their return themselves, it can get a little sticky. Parents can provide information to the IRS, but can’t do anything else with the return – that is, unless, your children wrote you in as a third-party designee who has permission to discuss the return with the IRS. This designation doesn’t allow parents to receive their children’s refund or agree to any further tax liability. It is a safe way for parents to remain involved while still respecting their children’s freedom to file on their 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 Children’s Unearned Income on Your Return
If your children each received $10,500 or less in interest and dividends during the year, you might be able to include their income on your own tax return instead of filing one separately. This can be a real time-saver for families in which children own stocks or bonds that generate income. However, if you make this election, you may end up owing more tax on your children’s income. This is because you lose the preferential tax treatment of capital gains distributions and qualified distributions if you report your children’s investment income on your return.
Keep the following in mind:
- This only applies if children only have unearned income. Earned income cannot be filed on your return.
- Children have to be 19 or younger (or 24 or younger if they are full-time students).
- If the unearned income is $2,100 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 by including a child’s income on your return.
- 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 children.
If you find that your children’s unearned income is more than $2,100, 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 want to consult an accountant, especially if your children expect to receive unearned income for a few years in a row (if they own a dividend-bearing stock, for instance). For more details, check out Publication 929, Tax Rules for Children and Dependents.
Filing taxes can be an important financial milestone for children. If yours are old enough to learn and understand, try to involve them in the process and start them off on the right foot toward becoming responsible, tax-paying citizens. They may enjoy a refund check now, but – more importantly – they’re sure to appreciate the early introduction to this complex process later in life.
Have your children filed tax returns?