Chapter 07 - Individual Income Tax Computation and Tax Credits
Earned income is income earned by the taxpayer from services or labor. Unearned income is
from investment property such as dividends from stocks or interest from bonds.
8. [LO 1] Does the kiddie tax eliminate the tax benefits gained by a family when parents
transfer income-producing assets to children? Explain.
No. Though the kiddie tax significantly limits the benefit of shifting income producing assets to children, it does not eliminate it. The kiddie tax does not apply unless the child has unearned investment income in excess of $1,900 ($950 standard deduction plus an additional $950). That is, parents can shift up to $1,900 of unearned investment income to a child without the child paying the kiddie tax (paying tax on income at the parent’s marginal tax rate).
9. [LO 1] Does the kiddie tax apply to all children no matter their age? Explain.
No, the kiddie tax applies to children who have net unearned income in excess of $1,900 if the children (1) are under age 18 at the end of the year, (2) are age 18 at the end of the year and do not have earned income in excess of half of their support, or (3) are over age 18 and under age 24, are full-time students, and don’t have earned income in excess of half of their support (excluding scholarships).
10. [LO 1] What is the kiddie tax and on whose tax return is the kiddie tax liability reported?
The kiddie tax is a tax at the parent’s marginal rate on the child’s unearned income in excess of $1,900. Generally, the kiddie tax liability is reported on the child’s tax return. However, the parents can make an election to include on their own return the child’s gross income in excess of $1,900.
11. [LO 1] Lauren is 17 years old. She reports earned income of $3,000 and unearned income of
$2,000. Is she likely subject to the kiddie tax? Explain.
Yes, Lauren is under age 18 at year end and her unearned income exceeds $1,900 so she is subject to the kiddie tax. Note that the kiddie tax base is the child’s net unearned income. Net unearned income is the child’s gross unearned income minus $1,900 ($950 of the child’s standard deduction (even if the child is entitled to a larger standard deduction—in this case, Lauren would be allowed a $3,300 standard deduction but the kiddie tax still applies) plus an extra $950). Consequently, the kiddie tax does not apply unless the child has unearned income in excess of $1,900 ($950 + 950).
12. [LO 2] In very general terms, how is the alternative minimum tax system different from the
regular income tax system? How is it similar?
The AMT system is different in that it taxes a more broad or inclusive tax base than the regular income tax. The AMT is designed to tax an income base that more closely reflects economic income than does the regular income tax system. Many items that are deductible for AMT
purposes are not deductible for regular tax purposes. Further, certain types of income included in the AMT base are not included in the regular income tax base. Also, the AMT rates are different from those for the regular income tax. The AMT system is similar to the regular tax system in that the starting point for computing the AMT tax base is regular taxable income.