For children who are claimed as dependents for child tax credit purposes, knowing whether or not they need to file a return if they have income during the tax year can be tricky. Especially for small business owners who let their children work for the company they own, sometimes they find it to be a balancing act between paying them for the hours they work for the company, but keeping their child’s wages below the income threshold that would require them to file a return. Unearned income from investments can also play a role in requiring a child to file a tax return, so many parents and grandparents have to be mindful of how much they should invest under their child’s name.
First, it may be helpful to establish whether a child is a qualifying dependent. Five tests must be met in order for a child to be considered a qualifying child for the child tax credit: relationship, age, residency, support, and joint return. In order for a child to be considered a qualifying child they must be either your son, daughter, stepchild, adopted child, or other descendant (such as a grandchild) or your sibling, half sibling, step sibling, or niece or nephew not otherwise claimed on someone else’s return and who you provide more than half of the support for. They must also be under the age of 19 at the end of the year or under the age of 24 and a full-time student. Children who are permanently or totally disabled can be claimed as a qualifying child regardless of age. The child must also be younger than you or your spouse. They must have lived for you for more than half of the year and you must have provided more than half of their support. There are some exceptions to this rule when it is written in a divorce decree or separation agreement. The child can also not file a joint return with someone else during the year. So, if a 19 year old child is living with you while their spouse is in the armed forces, if they are a full-time student and meet the other necessary requirements, they can sometimes be claimed as a qualifying child on the parent’s return if they file married filing separately.
The primary factor in determining whether or not a qualifying child needs to file a return is whether or not they exceed the income limitation. The limit changes every year, but in 2022 any child who earned more than $12,550, needed to file a tax return even if they were claimed as a dependent on another return. For “self-employed” children, the amount of income they can earn is significantly lower. In 2022, any qualifying child who earns more than $400 must file a return. In 2023, unearned income such as interest and dividends are tax-free up to the first $1,250, then the next $1,250 is taxed at the child’s tax rate, then the remaining income above the $2,500 is taxed at the parents’ marginal tax rate. This is known as the “Kiddie Tax”.
Parents can sometimes elect to claim their qualifying child’s unearned income on their personal return, if all of the following conditions are met:
Your child was under age 19 (or under age 24 if a student) at the end of the year
Your child had gross income only from interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends)
The interest and dividend income was less than $11,500
Your child is required to file a return for the tax year unless you make this election
Your child doesn't file a joint return
No estimated tax payment were made for the tax year and no overpayment was applied to the return under your child's name and SSN
No federal income tax was withheld from your child's income under the backup withholding rules
You are the parent whose return must be used when making the election to report your child's unearned income
Keep in mind that should you make this election, you will not be able to take advantage of the Kiddie Tax, but this may be cheaper than having a preparer file a separate return for your child. You will need to consult a tax professional to determine what is the best option.
Even if a child isn’t qualified to file a return under the income rules, they may still want to consider filing if they had any taxes withheld or qualify for certain tax credits. If they had federal or state taxes withheld, then filing a return is the only way they would get refunded on any tax overpayment. If they qualify for the Earned Income Credit or certain educational credits, they may want to consider filing. For educational credits, if the parents are high earners, they may want to consult a tax preparer to see who will benefit most from the credits. Some high earners don’t qualify for educational credits, but their qualifying child will and would be better served filing a return and claiming the credit.
Business owners should certainly consult a tax professional on what their best options are for employing their child. Paying your qualifying child for work performed for the business can offset income earned by high earning parents, but you need to be careful to pay them an appropriate amount for the work performed and to process the payments through payroll. As stated before, paying them as contract labor can result in them needing to file a tax return at a much lower level of income. And if you are still not sure if your child needs to file a return, you can always fill out the application at https://www.irs.gov/help/ita/do-i-need-to-file-a-tax-return or consult a tax professional who can guide you on your options.
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