The new "kiddie tax" slipped into the war on terror funding bill applies to a child if1) the child has not reached the age of 18 by the close of the taxable year and either of the child's parents is alive at such time; (2) the child's unearned income exceeds $ 1,700 (for 2007); and (3) the child does not file a joint return. The kiddie tax applies regardless of whether the child may be claimed as a dependent by either or both parents, and taxes the child’s net unearned income over $1,700 (for 2007) at the parents' tax rates if the parents' tax rates are higher than the tax rates of the child. The remainder of a child's taxable income (i.e., earned income, plus unearned income up to $ 1,700 (for 2007), less the child's standard deduction) is taxed at the child's rates, regardless of whether the kiddie tax applies to the child.
The kiddie tax is calculated by computing the "allocable parental tax." This involves adding the net unearned income of the child to the parent's income and then applying the parent's tax rate. A child's "net unearned income" is the child's unearned income less the sum of (1) the minimum standard deduction allowed to dependents ($ 850 for 2007), and (2) the greater of $850 (for 2007) or the amount of allowable itemized deductions that are directly connected with the production of the unearned income.
Effective for tax years beginning after May 25, 2007, the Act expands the kiddie tax to apply to children who are 18 years old or who are full-time students over age 18 but under age 24. The expanded provision applies only to children whose earned income does not exceed one-half of the amount of their support.