Kiddie tax complexity grows

The “kiddie tax” was enacted in 1986 as what was intended to be a simple-enough mechanism to prevent a small number of wealthy parents from shifting income-producing assets to young children who were in lower tax brackets. One reason the kiddie tax originally applied only to children age 14 and younger was to minimize complexity. The assumption was that few children under 14 would have substantial earned income or complicated financial situations.

Even so, almost immediately after enactment—and years before the age was raised—there were calls to reduce its complexity. The later increases in the age from 14 to 23 caused an explosion in the number of taxpayers required to deal with the complexity. While there is no exact way to measure that complexity, it is telling that the 34-page IRS Publication 929, Tax Rules for Children and Dependents, devotes at least 20 pages, rife with worksheets, to the taxation of dependents with investment income.

Complexity begins with the option for parents to “simplify” matters by allowing them to include the child’s income on the parents’ own return instead of filing a separate return for the child. First, the option permitting parents to include the income on their own returns has limitations that must be identified: The child’s investment income can consist of only interest, dividends, and certain capital gain distributions, and it cannot exceed a certain limit that changes from time to time. In addition, no estimated tax payments can have been made in the child’s name, and the child must not be subject to backup withholding. Furthermore, the election to include the income on the parents’ return may have negative tax consequences.

Filing a separate return for the child offers its own set of complexities. Two sets of calculations must be done: for the ordinary tax liability and the kiddie tax liability. For parents with more than one child, allocations are required to determine the kiddie tax attributable to each child. The filing process itself also becomes complicated. A child with a “simple” return cannot file until the parents’ return is filed. Gathering sibling information can be difficult, particularly if children are away at college or elsewhere. Moreover, if the parents file their income tax return on extension, the child(ren)’s return(s) must be extended as well. If any one of these returns is later amended, all may require amendments.

Compliance is further complicated for parents who are unmarried, separated, remarried, or treated as unmarried for tax purposes, because it is more difficult to determine the amount of parental income to be used to calculate the tax.

For a detailed discussion of the issues in this area, see “The Kiddie Tax: Inequitable Consequences and the Need for Reform,” by Gerri B. Chanel, CPA, in the February 2015 issue of The Tax Adviser.

—Alistair M. Nevius, editor-in-chief, The Tax Adviser

Also look for articles on the following topics in the February 2015 issue of The Tax Adviser:

• An update on developments affecting partners and partnerships.
• A look at the issue of federal vs. state health insurance exchanges.
• An examination of the differences between Sec. 7216 and the AICPA rule on confidential client information.

The Tax Adviser is the AICPA’s monthly journal of tax planning, trends, and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or email taxsection@aicpa.org for a subscription to the magazine or to become a member of the Tax Section.