Taxation of Dependent Unearned Income

[Ruth]

I'm a U.S. citizen residing in Canada with my non-U.S.-person husband and my 15-year-old U.S. citizen son.

I filed as Married Filing Separately. Since I have little income, I paid no tax since my Standard Deduction was more than sufficient to cover my total income.

Since my son is a dependent, my understanding is that he must file with IRS, since his 2023 Gross Income was greater than his Earned Income plus $400. Since he had unearned income of $681, it seems that he ends up paying U.S. tax on the $681 after he uses the Foreign Earned Income Exclusion to exclude his $5836 of Earned Income. That's in spite of the fact that I didn't need to claim a deduction for him to reduce my taxable income to $0.

Questions:
1. Does this sound right? In Canada my son pays $0 tax.
2. Is this a case where the U.S. tax code makes a dependent pay tax on unearned income, whereas Canada does not? If that's true, it seems that he pays tax on his unearned income (when it's over $400) until he's 19 and gets his own Standard Deduction?

[nelsona]

Yes, this is correct. Known as the kiddie tax.
Rules may have changed, but there was a provision where the parent could include this income on their return. Look into that.

[Ruth]

OK, thanks for that.

I guess Form 8814 ("Parents’ Election To Report Child’s Interest and Dividends") is likely the one you're referring to (https://www.irs.gov/pub/irs-pdf/i8814.pdf). Unfortunately, one of the form's many disqualifiers is the child having earned income to report, so I guess it won't help us.

I read that the kiddie tax was created because some parents were hiding investment income by putting their investments in a child's name, so the kiddie tax closed that loophole. Just a case of some taxpayers' abuse resulting in pain for kids who legitimately have investment income of their own, I suppose.

[Ruth]

OK, thanks for that.

I guess Form 8814 ("Parents’ Election To Report Child’s Interest and Dividends") is likely the one you're referring to (https://www.irs.gov/pub/irs-pdf/i8814.pdf). Unfortunately, one of the form's many disqualifiers is the child having earned income to report, so I guess it won't help us.

I read that the kiddie tax was created because some parents were hiding investment income by putting their investments in a child's name, so the kiddie tax closed that loophole. Just a case of some taxpayers' abuse resulting in pain for kids who legitimately have investment income of their own, I suppose.

[Ruth]

I guess there's no way to delete a duplicate post?

First time I submitted my reply I got an error saying that the server could not handle the request, so I submitted again. When I got the same error I went back to the original post and found two copies of my reply. Ugh.

[Ruth]

I have one more question for clarification re how this relates to the Foreign Earned Income Exclusion:

According to Pub. 501 my son needs to file, since his gross income is greater than his earned income + $400:
https://www.irs.gov/publications/p501#e ... 4,13%2C450)%20plus%20%24400.

However, according to Topic 551, since my son is a dependent, his standard deduction for 2023 equals his earned income + $400:
https://www.irs.gov/taxtopics/tc551#:~: ... g%20status).
But does this apply to kids who also use the FEIE (2555)?

If he uses the Foreign Earned Income Exclusion it appears that his unearned income won't incur tax until it exceeds his earned income + $400 (based on the Standard Deduction defined in Topic 551). Does that sound right?
Here are the numbers:
Earned Income: $5836
Unearned Income: $681
FEIE: -$5836
Standard Deduction: $6236
That would reduce his taxable income to zero, but seems to contradict the intention of the kiddie tax.

So my question: Does the above definition of a dependent's standard deduction still hold true even for a child dependent who claims the FEIE?

Hopefully my Q makes sense.

[nelsona]

He certainly can use FEIE. some limits come in to play, but your software will figure it

[Ruth]

I've never had any luck using the tax software, but I decided to try again this year for the filing for my Canadian-born, U.S.-citizen son.

As I expected, the software started asking stupid stuff like asking for a permanent address with a U.S. state, etc. Seems that the tax software has no clue that there are actually U.S. citizens who have never lived in the U.S. Every time I try to use tax software, it's just a big waste of time. I always hit a dead end somewhere along the way.

As a result, several years ago I decided that I couldn't do much better than use Free File Fillable Forms. Of course, that means that I need to know the rules a bit better, but there seems little alternative. So this time around I've just resorted to taking my guidance from the IRS help pages re the Standard Deduction for a Dependent. Strange thing is that if I try to use the IRS's online Interactive Tax Assistant, after answering all the questions, it tells me that my son's Standard Deduction is the full (normal) Standard Deduction ($13,850), which seems to completely ignore the kiddie tax (yes, I told it his date of birth) and disagrees with the result I get from just following the guidance in the Publication 501. The ITA cannot be right because it asks nothing about my son's earned income and unearned income, even though I told it he was a dependent. So even the IRS doesn't always agree with itself. (sigh)

[Ruth]

Here's a conversation I just had with the Interactive Tax Assistant (ITA) that illustrates how it gets it wrong when I ask it for my son's Standard Deduction (at least, compared to what Pub. 501 says):

What tax year are you asking about?
2023

What was your marital status on the last day of 2023?
Single, unmarried, or legally separated

What is your filing status for 2023?
Single

Will your 2023 tax return cover a 12-month period?
Yes

What is your date of birth?
01/01/09

Were you eligible to be claimed as a dependent on another taxpayer's return for 2023?
Yes

Were you blind on the last day of 2023?
No

Did you have a qualified disaster loss of personal-use property from a federally declared disaster?
No
____________________

And here's how the ITA responds after answering the above questions:

Your Standard Deduction in 2023
Your filing status is single
$13,850.00

Yes, the ITA page offers a disclaimer re the accuracy of its answer. But if I can't trust the result, then, well, it offers no value.

[nelsona]

Correct. Even speaking to a live IRS telephlunkie is rarely going to help; a robophlunkie is even less helpful.

You are really using the software to get the result, not necessarily e-file. Put whatever you need in fields to get past any administrative roadblocks.

Obviously, those who use FEIE usually live in foreign countries.