Some or all of your child’s investment income – including investment income earned in California – may be taxed at your higher rate rather than your child’s lower rate. Investment income includes interest, dividends, capital gains, and other unearned income. This is not to be confused with wages and other earned income received by your child of any age that are taxed at your child’s normal rate.
In California, the amount not taxed is $850. You compute the California State tax by using Form 3803 “Parents’ Election to Report Child’s Interest and Dividends”.
If you make this election, your child will not have to file a California State income tax return. You may report your child’s income on your California income tax return even if you do not do so on your federal income tax return. You may make this election in California if your child meets all of the following conditions:
Was under age 14 at the end of 2006, Note: A child born on January 1,
1993, is considered to be age 14 at the end of 2006;
Is required to file a 2006 return;
Made no estimated tax payments for 2006;
Had gross income for 2006 that was less than $8,500;
Had income only from interest and dividends;
Did not have any overpayment of tax shown on his or her 2005 return applied to the 2006 estimated taxes; and
Had no state income tax withheld from his or her income (backup withholding).
Computing the federal income tax applicable to your child only applies to children who are under the age of 18. For 2006, it applies if your child’s total investment income for the year was more than $1,700.
Form 8615, “Tax for Children Under Age 18 With Investment Income of More Than $1,700”, is what you need to use to figure your child’s tax. When you’re done, attach the Form to your child’s federal income tax return.
Alternatively, as a parent you can choose to report your child’s investment income on your own individual income tax return. Generally speaking, this option is available if your child’s income consists entirely of interest and dividends (including capital gain distributions) and the amount received is less than $8,500. However, you ought to first speak with your accountant because choosing this option may reduce certain credits or deductions you may claim.
More information can be found in IRS Publication 929, “Tax Rules for Children and Dependents”.