Teen Investors and Taxes
Updated February 12, 2023
An in-depth discussion of the tax rules that apply to your Teenvestor’s investment activities through a custodial account is certainly beyond the scope of this article. Nevertheless, here are some important things you should know about the basic tax rules that govern when an income tax return must be filed for your Teenvestor. We are not tax advisors so you should consult one to be sure you know if your teen investors will owe any taxes.
As a parent, you should monitor the amount of investment income that your Teenvestor makes (probably through a custodial account). The IRS defines investment income (also known as unearned income) as the combination of interest, dividends and capital gains. Investment income should not be confused with earned income, which includes salaries, wages, taxable scholarships and grants. Let’s examine three circumstances when your child receives 1) only unearned income 2) only earned income, and 3) both unearned and earned income. The IRS describes the circumstances under which your child must pay taxes in the following publication: Publication 929.
If Your Teen Receives Only Unearned Income
In most instances, your Teenvestor, as a single dependent, will not be required to file or pay taxes on the first $1,100 of investment income (i.e. unearned income). However, once his investment income exceeds $1,110 he must file a tax return or, as discussed below, you may choose to include his investment income on your own tax return.
This unearned income will be reported on his tax return, and the amount owed will be calculated on Form 8615, which is to be attached to his return.
The truth is that it is very unlikely that your Teeevestor will make more than $1,100 in unearned income because that would take a lot of investments to make such profits in any assets like stocks and bonds. In addition, this type of income is generally recognized when stocks and other assets are actually sold. So, if your Teenvestor invests in stocks but does not sell it, there is no unearned income associated with that investment. Sure, he may get dividends on stocks, but that will most likely be a tiny amount.
Parents can elect to include the investment income of their Teenvestors who are under 19 years of age (or under age 24 if the child is a full-time student) on their own returns. Parents can make this election if their Teenvestor’s investment income is more than $1,100 and less than $12,400. If you elect to report this income on your own tax return, your Teenvestor won’t have to file a separate return. A parent’s tax return that includes the investment income of children must be accompanied by a completed Form 8814.
If Your Teen Receives Only Earned Income
Your Teenvestor has to file a tax return if his earned income is more than $12,950. Some tax experts recommend that they file a tax return anyway if he makes less than this amount since he may be able to get money back if too much tax has been withheld.
If Your Teeen Receives Both Earned and Unearned Income
Gross income is used to determine whether your Teenvestor has to file a tax return when he has both investment income and earned income. Gross income, also known as “before-tax” income, is loosely defined as the total of earned income and investment income before any deductions for taxes are taken. Tax returns are required to be filed if your Teenvestor’s gross income for the year exceeds the greater of a) $1,150 or b) his earned income plus $400, up to a total of $12,950. Once your Teenvestor’s earned income (typically, wages from employment) exceeds $12,950, a tax return must be filed regardless of whether he has any investment income. In addition, if your Teenvestor does not have any investment income and is self-employed – that is, if he is an entrepreneur – he will have to file a tax return if his net profit exceeds $400.
Your Child’s Tax Bracket (Includes the Kiddie Tax)
Obviously, understanding when your Teenvestor is required to file a tax return is just one piece of the puzzle. It is also important to understand how to figure the tax rate that will be applied to his investment income.
Your Teenvestor is required to pay taxes on investment income exceeding $1,150. The tax rate that will apply to this income depends upon whether your Teenvestor is younger than 19 or not. If he is under 19 and has investment income, he is subject to the kiddie tax. Technically speaking, the kiddie tax is not actually a tax but rather a restriction that seeks to prevent parents from transferring their investment assets to their children under 19 to shield their income from taxes.
Under the kiddie tax, investment income over $1,150 and up to $2,300 will be taxed at your Teenvestor’s tax rate. For most Teenvestors, this should probably be 10%. Any investment income over $2,300 will be taxed at the parent’s tax rate.