Kiddie Tax: How Unearned Income for Dependents Is Taxed

The kiddie tax is a rule that forces certain unearned income—dividends, capital gains, interest—earned by a minor dependent to be taxed at the parent’s marginal tax rate instead of the child’s own (usually much lower) rate. Once a child’s unearned income exceeds an inflation-adjusted threshold, the excess is taxed as if it were the parent’s income, eliminating a common tax-avoidance strategy of shifting investment assets to children.

The original problem: income-shifting strategies

Before the kiddie tax existed, parents could reduce their family tax bill by gifting appreciated stocks or high-yielding bonds to minor children, whose income would be taxed at the child’s bracket—often 0% or 10%—rather than the parent’s (potentially 37%). A parent in the top bracket could shift tens of thousands of dollars of dividend income to a child and pay almost no tax.

In the 1980s, Congress closed this loophole by enacting the “Kiddie Tax” rule, formally codified in Internal Revenue Code Section 1(g). The rule recaptures unearned income above a threshold and taxes it at the parent’s rate, eliminating most of the incentive to gift investments to children.

How the threshold works

In 2024, a child can earn approximately $1,300 in unearned income before the kiddie tax applies. This threshold is indexed annually for inflation, so it changes year to year.

The first $1,300 (roughly) is taxed at the child’s own rate, which is often 0%. The second $1,300 is also taxed at the child’s rate (typically 10%). Any unearned income above roughly $2,600 is taxed at the parent’s marginal rate.

The exact figures depend on whether the child is claimed as a dependent on the parent’s return and whether the child files their own return. A child with earned income (wages) can increase these thresholds through the standard deduction. But unearned income is the focus of kiddie tax.

Example: Sarah, age 15, receives $1,000 in dividends from a stock gift from her grandmother. Sarah owes no tax because her unearned income is below the ~$1,300 threshold and she has no other income. If Sarah also earns $5,000 as a summer babysitter, her standard deduction ($7,500 in 2024 for a dependent with earned income) shelters both the wages and the dividends—no tax owed.

Example 2: Michael, age 16, inherits a bond fund that generates $8,000 per year in interest. Michael’s first ~$1,300 is taxed at his rate (0%). The next ~$1,300 is also taxed at his rate (10%). The remaining $5,400 is taxed at Michael’s parent’s marginal rate—if the parent is in the 24% bracket, Michael’s parents owe approximately $1,296 in tax on his inheritance income, even though Michael earned none of it.

Whose rate applies: kiddie’s or parent’s

The kiddie tax rule means that once a child’s unearned income exceeds the threshold, the Internal Revenue Service (IRS) applies the parent’s tax bracket—not the child’s—to that excess.

This requires the IRS to know the parent’s bracket, which is why the child’s return must identify the parent or the parent must attach a calculation to their own return. The computation is made on Form 8615, which determines the kiddie tax liability.

Importantly, the rule applies only to unearned income. Wages from employment—a teenager’s summer job or part-time work—are always taxed at the teenager’s own rate, regardless of amount. This is why parents often encourage children to earn wages rather than live entirely on investment income.

Age limits: when the kiddie tax stops

The kiddie tax applies to a child until the calendar year in which one of these events occurs:

1. The child reaches age 18
2. The child reaches age 24 and is a full-time student (enrolled at least half-time at an accredited educational institution)
3. The child dies

Once a child is past these thresholds, all of their income—earned or unearned—is taxed at their own rate, regardless of amount or the parent’s bracket.

A child who turns 18 mid-year is governed by kiddie tax rules only through December 31 of the year they turn 18. Starting January 1 of the following year, the rule no longer applies.

Filing options and the kiddie tax

A child can choose to file their own return or be claimed as a dependent on the parent’s return. These decisions affect the kiddie tax calculation:

• Child files own return: The child’s standard deduction reduces taxable income first. Kiddie tax applies only to unearned income above the threshold.
• Child claimed on parent’s return: The child still must file if unearned income exceeds their standard deduction threshold, and kiddie tax is calculated the same way.

If the child’s unearned income is very small (below the threshold), the child may owe no tax at all and may not be required to file. However, if the child has earned income, they should file to claim any refundable credits, such as the earned income tax credit, which can result in a refund.

Parents should be aware that claiming a child as a dependent also limits the child’s ability to claim their own standard deduction (the child’s standard deduction is reduced if the parent claims them). This can increase the child’s taxable income and kiddie tax liability.

Strategies to minimize kiddie tax

Several legitimate approaches can reduce or eliminate kiddie tax:

Gift appreciated stock. If a parent gifts appreciated stock to a child and the child later sells it, the child realizes a long-term capital gain (if held > 1 year). Long-term capital gains for children in the 0% or 10% bracket are taxed at 0%—a powerful advantage. The parent avoids the capital gains tax entirely, and the child pays nothing (or a small amount depending on the threshold).

Use tax-advantaged accounts. Contributions to a 529 plan (education savings) or a custodial Roth IRA (if the child has earned income) grow tax-free and avoid unearned income triggers.

Encourage earned income. If a teenager has unearned income, earning wages from a job increases the standard deduction threshold, potentially sheltering the unearned income entirely. Additionally, wages are always taxed at the child’s rate.

Time income recognition. Delaying the receipt of dividends or capital gains until the child turns 18 or 24 can shift that income out of the kiddie tax window.

Distribute appreciated assets instead of income. Some trusts and estates are permitted to distribute appreciated property to beneficiaries. If a child receives property directly (rather than income from that property), the distribution is not taxable income—though subsequent investment income from that property remains subject to kiddie tax.

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