Interest Income Tax Rate: The Kiddie Tax on Children’s Interest Income
If your child earns interest from a custodial account or savings bonds, the tax treatment depends on the amount. Under the most recently published IRS figures, a child’s first $1,350 of unearned income (interest, dividends, and capital gains combined) is untaxed, the next $1,350 is taxed at the child’s own rate, and anything above $2,700 is taxed at the parents’ marginal rate.10 These rules apply to children under 18, and to full-time students under 24.
The kiddie tax exists to prevent parents from shifting investment income into their children’s names to take advantage of lower brackets. If your child’s total unearned income stays under $13,500, you may be able to include it on your own return instead of filing a separate return for the child.
Interest income goes on your Form 1040, but the specifics depend on how much you earned and whether you received the right paperwork.
Form 1099-INT and the $10 Threshold
Any institution that pays you $10 or more in interest during the year must send you a Form 1099-INT by the end of January.11 Box 1 shows your total taxable interest, and Box 4 shows any federal tax already withheld. Check each form against your bank statements. Errors happen, and the IRS receives a copy of every 1099-INT filed, so a mismatch between what you report and what they have on file will trigger a notice.
Here’s the part many people miss: you owe tax on all interest you earn, even amounts under $10 and even if you never receive a 1099-INT. The reporting threshold only determines whether the bank has to send you the form, not whether the income is taxable.4
Schedule B
If your total taxable interest for the year exceeds $1,500, you need to complete Schedule B and attach it to your Form 1040.12 The schedule requires you to list each payer individually along with the interest amount. The total then flows to Line 2b of your 1040. If your total is $1,500 or less, you can skip Schedule B and enter the amount directly on your main return.
Backup Withholding
In certain situations, banks and brokerages withhold 24% of your interest payments and send it to the IRS before you ever see it. This happens when you haven’t provided a valid taxpayer identification number, when the IRS notifies the payer that your TIN is incorrect, or when the IRS flags you for underreporting interest income on past returns.13 If backup withholding was applied to your account, the amount appears on your 1099-INT and counts as a tax payment you can claim on your return.
Deducting Early Withdrawal Penalties
If you cashed out a CD before its maturity date and the bank charged an early withdrawal penalty, you can deduct that penalty as an adjustment to income on Form 1040. This is an above-the-line deduction, meaning you don’t need to itemize to claim it. The penalty amount will appear on your 1099-INT, and the deduction directly reduces your adjusted gross income.
AUTHOR: LEGALCLARITY.ORG / LegalClarity Team
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