Kiddie Tax Rules

The Kiddie Tax Rules (Section 1(g) of the U.S. Internal Revenue Code) are provisions that tax a dependent child’s unearned income at the parents’ marginal tax rate rather than the child’s (typically lower) rate, preventing high-income parents from shifting investment income to children and harvesting their lower tax brackets. The rules apply primarily to children under 18, and under certain conditions, to children 18–24 who are full-time students.

History and purpose: closing the income-shifting loophole

Before kiddie tax rules, high-income parents could reduce family income tax by gifting appreciated securities or bonds to children. The child would receive dividend and interest income taxed at the child’s bracket (often 0% if below the standard deduction or in the 10% bracket), while the parent’s income was reduced. Over a generation, this could save tens or hundreds of thousands in taxes.

Congress enacted kiddie-tax rules in 1986 (Tax Reform Act) to close this loophole. Starting in 1987, a child’s unearned income above a threshold was taxed at the parents’ rate. The strategy was no longer viable; parents could no longer shift income to exploit the child’s lower brackets.

The mechanics: tiered taxation

A child’s unearned income is taxed as follows:

1. The first $1,250 (2024, adjusted annually) is tax-free (standard deduction equivalent).
2. The next $1,250 is taxed at the child’s ordinary rate (typically 10% in 2024).
3. Unearned income above $2,500 is taxed at the parents’ marginal rate.

Example: A parent in the 37% bracket gifts $100,000 of dividend-paying stock to a 10-year-old child. The child receives $3,000 in annual dividends. Of that:

• $1,250 is tax-free
• $1,250 is taxed at 10% = $125
• $500 is taxed at 37% = $185
• Total tax: $310 (instead of $1,110 if the parent retained the stock)

The savings are real but modest—$800 in this example. The strategy is far less attractive than it was pre-1986.

Unearned vs. earned income distinction

The rules apply only to unearned income: dividends, interest, capital gains, rental income, and passive business income. Earned income—wages, salary, self-employment income—is taxed at the child’s bracket and is not subject to kiddie tax.

This is why many tax planners recommend involving children in the family business. If a parent owns a business, they can hire the child at a reasonable wage (12-year-olds can perform filing, data entry, and inventory tasks). The child earns, say, $8,000 per year—all below the standard deduction, so zero tax—while the parent deducts the expense. No kiddie tax applies.

The age cutoff: 18, 23, and 24

The kiddie-tax rules apply to children under 18. For 18-year-olds, the rules stop applying unless the child is a full-time student. For full-time students, the rules extend to age 24 if their earned income is less than half their support. A 20-year-old college student supported by parents, earning $5,000 from a summer internship, still falls under kiddie tax if unearned income exceeds the threshold. Once the student graduates or stops being full-time, or if earned income exceeds the support threshold, kiddie tax ends.

This cutoff creates a planning incentive: high-income parents sometimes defer gifting appreciated securities until a child turns 18, or accelerate the transition to self-sufficiency.

Interaction with alternative minimum tax and net investment income tax

A child subject to kiddie tax is also potentially subject to the Net Investment Income Tax (NIIT), a 3.8% surtax on net investment income for high-income taxpayers. The NIIT applies if a child’s modified adjusted gross income exceeds $200,000 (single filer in 2024). For a child with $3,000 in unearned income, the NIIT threshold is rarely exceeded, but for children with large trust income or significant inherited securities, it can.

The Alternative Minimum Tax (AMT) also applies to children. If a child has substantial unearned income and is subject to kiddie tax at the parents’ marginal rate (which is often above the AMT brackets for high earners), AMT can introduce further complexity. Form 8615 coordinates these layers.

Trusts and estate planning implications

Kiddie-tax rules profoundly affect trust planning. A grantor trust that accumulates income is often used to defer income to beneficiaries. However, if the beneficiary is a minor, accumulated income is taxed at the parents’ rates under kiddie tax, eliminating much of the tax advantage. As a result, planners often structure trusts to distribute income annually to children (triggering the child’s low tax bracket) rather than accumulate, or defer distributions until age 18–24 when kiddie tax ends.

A generation-skipping transfer tax exemption often pairs with kiddie-tax planning: a grandparent gifts appreciating assets to a grandchild in trust, accepting a higher current tax on unearned income (via kiddie tax) in exchange for multi-generational appreciation exempt from transfer taxes.

2024 updates and indexing

The threshold amounts ($1,250, $2,500) are indexed annually for inflation. In 2024, they remain at $1,250 and $2,500 respectively. The thresholds were last increased in 2023. Planners should monitor indexing announcements; higher thresholds reduce the reach of kiddie tax, potentially reviving income-shifting strategies.