I understand your quandary @3scoutsmom.
It is good to be informed.
The first determinator for the tax rate used for kiddie tax, is the parent income.
The second is the unearned income subject to kiddie tax.
Also how much older is your D than your S? Do you think that maybe she could earn enough earned income at her job or an internship to be able to pay more than 50% of her own support? Then the she could potentially file an independent tax return in the future and kiddie tax would not apply?
That is in the theoretical calculation of parent income plus all unearned children’s income to get the tax rate for the children.
Yes, if kid 1s income leaves the parents in the same tax bracket, but kid 2s income pushes them into the next tax bracket, both kids use the resulting higher tax rate on their returns. Again, when you apply this outside the concept of investments, it does seem unfair or illogical. (But neither of those are important in the tax code:)
1). Child uses tax form 8615, which includes all “unearned income”, the specific definition of which includes scholarships over and above tuition, fees books, etc.
2). The total is then taxed at a rate calculated by taking:
-parent taxable income
Plus
-all childrens’ income on Forms 8615 (includes siblings, line 7)
And looks for the tax rate on this new, combined total income. The child income uses that rate to determine tax due on their own income.
Each child does this separately to find the combined higher rate, then each uses that rate only on her portion of unearned income.
@3scoutsmom
Let’s look at an example
D’s taxable scholarship (r&b) $15,000
S’s taxable scholarship (stipend, travel, etc,) $20,000
unearned income subject to kiddie tax: D $8,700 ($15,000-$6,300 std ded)
S $13,700 ($20,000 -$6,300)
Parent taxable income (AGI minus item ded or std ded, minus personal exemptions) $30,000
Total of D and S unearned income: $22,400
Parent tax on $30,000 from tax table MFJ $3,576
Parent tax on $52,400 from tax table MFJ $6,936
Difference in parent tax $3,360 (total kiddie tax)
D’s part of kiddie tax $8,700/$22,400= 0.39 $3,3600.39=$1,310
S’s part of kiddie tax $13,700/$22,400=0.61 $3,3600.61=$2,050
They both pay a 15% tax rate D $1,310/$8,700=0.15
S $2,050/$13,700=0.15
If D had been the only one in this example to have income subject to kiddie tax, then her tax rate would still be 15%.
$30,000 parent taxable income plus $8,700 = $38,700
parent tax on $30,000 $3,576
parent tax on $38,700 $4,881
difference $1,305
$1,305/$8,700= 0.15
Also if D has $5,000 in income from working, that would bring her unearned income subject to kiddie tax up, because the standard deduction of $6,300 would cover less of her taxable scholarship income.
So if D had income subject to kiddie tax of $13,700 ($20,000-$6,300)
then together with brother the total income subject to kiddie tax would be $27,400
added to parent taxable income $30,000+$27,400=$57,400
parent tax on $30,000 $3,576
parent tax on $57,400 $7,686
difference $4,110
D’s kiddie tax $2,055 tax rate $2,055/$13,700=0.15
S’s kiddie tax $2,055 tax rate $2,055/$13,700=0.15
So in all of these scenarios where parent tax rate seems to be 15% and stays 15% even with adding $8,700, $22,400 or $27,400 of unearned income subject to kiddie tax, the tax rate also stays the same for each child.
Of course that might be the case in your situation, or not. Also once D files taxes independently she could possibly pay less in tax (10% bracket), but then the parent would lose one personal exemption, which might or might not change their tax rate, or parent income could go up, lots of variables.
But the bottom line is, that you are still better off having a $15,000 taxable scholarship.
Thanks @mommdc D is a freshmen this year and she has a campus job but it’s only $10 an hour for 10 hours a week and that’s about all she can manage. If scholarships could count toward support she’d be golden but alas it doesn’t work that way either and I’m guessing just because they call part of DS’s potential scholarship a “stipend” it wouldn’t count as support either. DD is doing a summer internship in Germany with paid stipend which I believe will be counted as unearned scholarship money as while which she’ll be required to get a German bank account to receive. I think there is a entirely different issue with foreign income but we’ll cross that bridge when we get to it. Taxes make my head spin!
I have three kids who are almost exactly two years apart in age. DD is on a five year track because of a double major so I will have 2 kids in college at the same time for 3 years and all 3 in college for 1 year.
I’ve already given DD bum advice about taxes mostly because I made assumptions without full understanding. I knew she would owe tax on scholarships used for room and board. I did not understand that most of the scholarships that she planned to use for that would be awarded during the first semester even though she planned to use half of them for second semester cost. I had a hard time separating school year and tax year and should have asked that the scholarships be deferred (at least they won’t come into play in next year’s taxes now). She worked all summer at an out of state Girl Scout camp, they took out state taxes which I thought she’d get back to off set her federal “kiddie tax” turns out that state includes all unearned income by some percentage of total income so because of her scholarships, even though she doesn’t live in that state she had to pay $25 to file to get $7 back. I should have told her to work at a local GS camp, we have no state tax!
Thank you very much for your detailed examples!
@HImom, you are allowed to withdraw an equivalent amount from a 529 if you get a merit scholarship. There is no penalty and taxes are owed only on the earnings portion of the withdrawal. We did consider those earnings as unearned income subject to the kiddie tax.
Ok. Good to know. All I know was our CPA warned us to be very careful with 529 accounts because penalties on them are very expensive.
Also isn’t a small portion of unearned income taxed at the kid’s rate? $2100 should be at kid’s rate.
Yes. Kids can have some at their own rate. Plus if they work, that is at their rate.
IRS taxes grants/FA for living expenses as unearned under the theory that the parent “should be” supporting the kid, so the benefit is really to them. Hence taxation at their rate. Fair or not, it just is. For poor families, it probably is not an issue. For more wealthy families, well, they can afford the increased rate I suppose. Honestly? OP, if the rate is higher, I’d pay the difference in tax bc it is really a parent issue, not the kid.