What Is the Kiddie Tax?
The kiddie tax is a tax imposed on income unrelated to employment earned by individuals 18 years of age or under—or dependent full-time students under age 24. Introduced as part of theTax Reform Act of 1986, it is designed to stop parents from registering investments in their children’s name to avoid paying taxes.
The kiddie tax threshold adjusts each year for inflation. In 2023, unearned income surpassing $1,250 is subject to the child’s tax rate, and anything above $2,500 is taxed at the guardian’s tax rate.
Key Takeaways
- The kiddie tax prevents parents from avoiding taxes by transferring large gifts of stock.
- All unearned income over the threshold is taxed at the parent’s marginal income tax rate rather than the lower child’s tax rate.
- It applies to all children who are 18 years of age or under—or dependent full-time students between the ages of 19 and 24.
- The kiddie tax applies to most unearned income that a child receives and does not apply to any salary or wages.
- In 2023, unearned income under $1,250 qualifies for the standard deduction under kiddie tax law.
How the Kiddie Tax Works
The kiddie tax is imposed on individuals under a certain age whose investment and unearned income is higher than an annually determined threshold. It applies to all children aged 18 and under at the end of the tax year as well as children who are dependent full-time students between the ages of 19 and 24.
The kiddie tax does not apply to children under 24 years of age who are married and file joint tax returns.
This rule is designed to prevent parents from exploiting a tax loophole where their children are given large gifts of stock. In this case, the child would then realize any gains from the investments and would be taxed at a far lower rate compared to the rate the guardians face for their realized stock gains.
The kiddie tax includes unearned income a child receives: interest, dividends, capital gains, rent, and royalties. Any salary or wages the child earns is not subject to the kiddie tax.
Adult children who turn 19—or 25 in the case of dependent full-time students—by the end of the tax year are not subject to the kiddie tax.
What Is the Kiddie Tax Rate for 2023?
Under the kiddie tax law, all unearned income over the threshold is taxed at the parent's marginal income tax rate rather than the child's tax rate.
In the 2023 tax year, unearned income under $1,250 qualifies for the standard deduction. The next $1,250 is taxed at the child's tax rate, which is very low—sometimes 0%—and then anything over is taxed at the guardian's tax rate, which could be as high as 37%.
The IRS taxes any income exceeding the predetermined threshold at the parent's tax rate.
How Is Kiddie Tax Reported?
There are generally two ways to go about reporting a child’s unearned income.
- The parent reports a child's interest, ordinary dividends, and capital gains distributions alongside their own tax return on Form 8814(Parent’s Election to Report Child’s Interest and Dividends)
- The child reports it on Form 8615(Tax for Certain Children Who Have Unearned Income), which is attached to the child’sForm 1040
The first option can be used when the child’s only income is interest and dividend income, including capital gains, and totals less than $11,000. If that’s not the case, the second route will have to be taken, presumably with the help of the parent.
History of the Kiddie Tax
The tax law originally only covered children under 14 years of age. Children under the age of 14 cannot legally work, which means that any income they received usually came from dividends or interest from bonds. However, the tax authorities realized that some guardians would take advantage of the situation and then give stock gifts to their older, 16-to-18-year-old children.
TheTax Cuts and Jobs Act of 2017temporarily changed the kiddie tax to use the tax rates that apply to estates and trusts rather than the tax rate of the child's parents. However, the Further Consolidated Appropriations Act 2020 retroactively changed it back to the parent's tax rate. For 2018 and 2019 returns, taxpayers could use either the estate tax rates or the parent's take rate for calculating the kiddie tax. For 2020 and beyond, the parent's tax rate applies.
Who Is Subject to Kiddie Tax?
The kiddie tax is imposed on individuals under 18 years old or dependent full-time students under 24 years old whose investment and unearned income is higher than an annually determined threshold.
What Is the Purpose of the Kiddie Tax?
The kiddie tax was created under the Tax Reform Act of 1986 to stop parents from registering income-producing investments in their children’s name to pay fewer taxes. Income received from investments is generally taxed at ordinary income tax rates, which is based on how much an individual earns.
What Percentage Is Kiddie Tax?
In 2023, unearned income under $1,250 qualifies for the standard deduction. The next $1,250 is then taxed at the child's marginal tax rate, and then all amounts over $2,500 are taxed at the parent's tax rate, which can vary from 10% to 37%.
How Do I Avoid Kiddie Tax?
Parents or grandparents can avoid the kiddie tax by keeping the child’s annual investment income at $2,500 or less. This can be accomplished in a number of ways, including investing in assets that don’t pay much in the way of income or dividends or in bonds where the payment of interest can be deferred until the child is no longer subject to the kiddie tax.
The Bottom Line
The kiddie tax, a tax imposed on individuals under a certain age whose unearned income is higher than an annually determined threshold, is designed to put an end to an old tax loophole and is something parents need to be aware of.
If you are investing on behalf of a child, consider speaking to a financial advisor or tax advisor. Firstly, it’s important to be aware of the rules and your obligations. And secondly, there are ways to limit and/or avoid this liability.
