Key Takeaways
- Taxes child's unearned income above $2,700 at parents' rate.
- Applies to investment income, not wages or earned income.
- Targets children under 19 or full-time students up to 23.
- Requires filing IRS Form 8615 if thresholds exceeded.
What is Kiddie Tax?
The kiddie tax is a U.S. federal tax rule designed to tax a child's unearned income above certain thresholds at the parents' marginal tax rate. This prevents families from shifting investment income to children to exploit lower tax brackets.
Unearned income includes interest, qualified dividends, capital gains, rents, and royalties, but excludes earned income such as wages or salaries. The tax applies primarily to minors and full-time students who meet specific criteria.
Key Characteristics
Understanding the kiddie tax involves grasping its main features and who it affects.
- Applies to: Children under 18, and those 18–23 who are full-time students with earned income below 50% of their support.
- Income type: Targets unearned income, including dividends and capital gains, but excludes earned income.
- Tax thresholds: The first $1,350 of unearned income is tax-free, the next $1,350 is taxed at the child’s rate, and income above $2,700 is taxed at the parents’ rate.
- Filing requirement: Children must file IRS Form 8615 if unearned income exceeds thresholds.
- Prevents tax avoidance: Stops families from shifting income to children in lower tax brackets.
How It Works
The kiddie tax calculates tax on a child's unearned income in tiers. The first $1,350 is sheltered by the child’s standard deduction, followed by $1,350 taxed at the child’s own rate, usually 10% or 12%. Unearned income above $2,700 is taxed at the parents’ marginal tax rate, which can be significantly higher.
This tiered system ensures income shifting does not result in lower overall tax liability. The tax applies to income in custodial accounts or brokerage accounts held in the child’s name, requiring careful planning if you manage family investments.
Examples and Use Cases
Here are some scenarios illustrating the kiddie tax in action:
- Dividend income: If your child receives dividends from shares of Dividend-paying stocks, such as those in the best dividend stocks category, their unearned income may trigger kiddie tax.
- Capital gains: Selling appreciated shares in a custodial account can generate capital gains subject to the kiddie tax.
- Student investments: A full-time student with investment income exceeding $2,700 will pay tax at the parents’ rates on the excess, affecting planning for education expenses.
Important Considerations
When managing a child's investments, be mindful of the kiddie tax thresholds and filing requirements to avoid unexpected tax bills. Strategies like favoring tax-advantaged accounts or focusing on tax-efficient ETFs can help reduce taxable unearned income.
Always consult a tax professional to navigate complex situations, including interactions with the 3.8% Net Investment Income Tax, and to ensure compliance with IRS rules for partnership income or other sources.
Final Words
Kiddie Tax ensures unearned income over $2,700 is taxed at the parents’ rate, limiting tax avoidance through income shifting. Review your child’s investment accounts and estimate potential tax impacts to plan effectively for upcoming tax years.
Frequently Asked Questions
Kiddie Tax is a U.S. federal tax rule that taxes a child's unearned income above certain thresholds at the parents' marginal tax rate to prevent income shifting for tax avoidance. It applies to unearned income like interest, dividends, and capital gains, but not to earned income such as wages.
The Kiddie Tax applies to children under 18, 18-year-olds if their earned income is 50% or less of their support, and full-time students aged 19 to 23 with earned income also 50% or less of their support. The child must have unearned income above the threshold for the tax to apply.
Unearned income such as interest, dividends, capital gains, rents, royalties, and taxable Social Security or pensions are subject to the Kiddie Tax. Earned income, like wages and salaries, is not taxed under this rule.
For 2025 and 2026, the first $1,350 of a child's unearned income is tax-free, the next $1,350 is taxed at the child's rate, and any amount over $2,700 is taxed at the parents' marginal tax rate. This tiered system helps prevent tax avoidance through income shifting.
A child must file IRS Form 8615 with their federal tax return if their unearned income exceeds $2,700 in 2025 or 2026. This form calculates the tax owed at the parents' tax rate on the child's net unearned income above the threshold.
No, parents cannot elect to include the child's income on their tax return if the Kiddie Tax applies. The child must file their own separate return when their unearned income exceeds the threshold requiring Kiddie Tax.
No, the Kiddie Tax only applies to unearned income like investment earnings. Earned income such as wages from a job is taxed at the child's own tax rate and is not subject to the Kiddie Tax rules.
