Kiddie Tax on Unearned Income

The kiddie tax is a rule that taxes a child’s net unearned income above an annual threshold at the parent’s marginal tax-bracket-investor rate, rather than the child’s own (usually lower) bracket. Designed to prevent tax avoidance through income-shifting to children, it applies to children under a specific age and significantly affects the return on custodial accounts, dividend income, and other passive investments held for minors.

The Rule and the Threshold

The kiddie tax applies to unearned income—dividend payments, interest, capital gains, and passive rental income—of a child under age 18. (The rule extends to age 24 for full-time college students with limited earned income.) The threshold for 2024 is approximately $1,300 of net unearned income (adjusted annually for inflation).

Here’s how it works:

• First ~$1,300 of unearned income is taxed at the child’s own rate, which is often 0% if the child has no other income (standard deduction).
• Unearned income above ~$1,300 is taxed at the parent’s marginal tax rate, not the child’s.

For example, if a parent is in the 35% federal bracket and their 14-year-old child receives $3,000 in dividend income from a custodial brokerage account:

• First $1,300: taxed at the child’s rate (likely 0%, producing no tax).
• Remaining $1,700: taxed at the parent’s 35% bracket, resulting in $595 of federal tax.

Without the kiddie tax rule, that same $3,000 would be taxed at the child’s rate (0%), producing no tax at all. The rule prevents high-income families from shifting investment income to children to escape taxation.

Age Thresholds and Student Status

The kiddie tax applies to:

• Children under 18 at the end of the tax year.
• Full-time students, age 18–24, if their earned income does not exceed half their support costs for the year. (This prevents college students working part-time from claiming the lower threshold.)
• Age 25 and over are exempt; they are taxed on all unearned income at their own rates, regardless of parental income.

The rules are strict. A student who works more than half their own support (pays for more than 50% of tuition, rent, and living expenses themselves) is no longer a dependent and kiddie tax does not apply. Once a child turns 24, even a student, kiddie tax is fully phased out.

What Counts as Unearned Income

Unearned income includes:

• Dividend and interest payments
• Capital gains from the sale of investments
• Rental or royalty income
• Income from partnerships, S-corporations, or trusts allocated to the child

Earned income (wages, salaries, self-employment income from a business the child runs) is exempt from kiddie tax. A child’s $5,000 summer job is taxed at the child’s own rate, not the parent’s rate. This exception means that encouraging a child to work does not trigger kiddie tax.

Custodial Accounts and Investment Strategy

Custodial accounts (UGMA and UTMA accounts) are a common vehicle for transferring assets to children for education or long-term savings. The kiddie tax rule has profound implications for their use:

Offsetting with tax-loss-harvesting: Some families deliberately realize capital losses in a custodial account to offset the child’s dividend and interest income. If a custodial portfolio has $2,000 of dividend income and $1,200 of unrealized losses in underwater stocks, selling those losses produces a $1,200 capital loss that can offset the dividends. Only $800 of net unearned income remains, which is below the threshold, avoiding kiddie tax entirely.

Holding growth stocks vs. dividend payers: Higher-income families sometimes favor growth stocks (which produce little or no dividend) over dividend-paying stocks in custodial accounts. Unrealized gains are not taxed until sold, and a child can harvest those gains gradually after reaching age 18 or 24, locking in their own lower tax rate. Dividends, by contrast, trigger kiddie tax immediately.

Timing and Tax-bracket-investor strategy: Families with children approaching age 18 may accelerate dividend or interest-generating positions until after the child’s birthday, allowing the child to be taxed at their own rate.

401k-plan and Roth-ira accounts: These are not custodial investments and are not subject to kiddie tax, but minors with earned income can contribute to a Roth IRA up to the amount of their earned income. This is a powerful tax-deferred or tax-free tool for working teenagers.

Calculating the Kiddie Tax

The kiddie tax is calculated on Form 8615 (Tax for Certain Children Who Have Unearned Income). The calculation:

1. Determine the child’s net unearned income (unearned income minus deductions directly connected to that income, like investment advisory fees).
2. If net unearned income exceeds the threshold (~$1,300), calculate tax on the excess at the parent’s marginal rate.
3. Calculate tax on the portion below the threshold at the child’s own rate.
4. Add both and report it on the child’s return.

The child’s parents’ brackets are used, not the child’s. If the parents file separately, the highest earning parent’s rate applies. If the parents are divorced, the custodial parent’s rate is used.

Common Misconceptions

“My child’s income is tax-free below the threshold.” Partially true. The first portion (up to ~$1,300) may be tax-free if it falls within the child’s standard deduction, but this assumes the child has no earned income. Once earned and unearned income combine, the calculation changes.

“I should avoid giving my child investments to avoid kiddie tax.” Not necessarily. Lower-income families may see no tax impact from kiddie tax because their marginal rate and the child’s rate are the same or close. For families in lower brackets, the tax on investment income in a child’s name may be minimal.

“The kiddie tax applies to all children.” Only to those under age 18 (or under 24 if a full-time student) with unearned income above the threshold. A 16-year-old with no investments is unaffected. A 25-year-old college student is unaffected.

Impact on Tax Planning

Families with significant assets use kiddie tax rules as part of broader tax-bracket-investor planning. Strategies include:

• Funding child education accounts (529 plans) with taxable investments to shift income, but using tax-loss harvesting to stay below the threshold.
• Timing gifts to occur after a child’s 18th birthday if large dividends or gains are anticipated.
• Using irrevocable trusts and other estate planning vehicles to shift income and wealth while minimizing kiddie tax impact.
• Encouraging teenage children to earn income (part-time jobs, self-employment) to build retirement savings in a Roth IRA tax-free.

See also