The kiddie tax is a set of tax rules designed to prevent parents from reducing their tax burden by shifting investment income to their children. It applies to children under the age of 18, or dependent full-time students under 24, who have unearned income from investments, such as dividends or capital gains. The tax rate for the kiddie tax follows the parents’ marginal tax rate once the child’s unearned income exceeds a certain threshold, which is adjusted annually. Understanding these limits and how the kiddie tax is applied can help manage potential tax implications on a child's investment earnings. A financial advisor can also work with you to develop a tax strategy and manage investments.
What Is the Kiddie Tax?
The kiddie tax was introduced in 1986 as part of the Tax Reform Act to prevent high-income families from avoiding taxes by transferring investments to their children.
Before the kiddie tax, parents could reduce their overall tax burden by taking advantage of the lower tax rates applied to children's unearned income. Congress passed legislation for the kiddie tax and the Internal Revenue Service (IRS) oversaw and enforced it, closing this loophole and ensuring that investment income transferred to minors gets taxed at rates comparable to the parents' rates.
Each year, there is a certain amount of unearned income that can be taxed at the child's rate before the kiddie tax applies. For income above this limit, the child is taxed at the parents' higher rate. This structure helps to prevent families from using children's investment accounts as a tax shelter, while still allowing minors to benefit from their own savings and investments.
Who Does the Kiddie Tax Apply To?
The kiddie tax applies to children under the age of 18 and dependent full-time students who are under 24 years old. It primarily targets minors and young adults whose unearned income, such as dividends, interest and capital gains, exceeds the annual threshold set by the IRS. The kiddie tax does not apply to earned income like wages or salaries, which are taxed at the child's own rate.
To determine if a child is subject to the kiddie tax, several factors are considered. First, the child must be under 18 or, if between 19 and 23, they must be a full-time student. Additionally, the child must have unearned income exceeding the annual threshold, which is $2,600 for the 2024 tax year (filed in 2025).
Importantly, if the child is age 18 at the end of the tax year, they cannot earn more than half of their own support for the tax year. Meeting these criteria, any unearned income above the threshold will be taxed at the parents’ higher marginal tax rate rather than the child's lower rate.
Kiddie Tax Threshold
The kiddie tax thresholds are adjusted annually to account for inflation. In 2024, the first $1,300 of unearned income is tax-free, the next $1,300 is taxed at the child’s rate, and any amount above $2,600 is taxed at the parents’ rate.
As an example, let's take a 16-year-old who receives $4,000 in unearned income from dividends and interest on their investment account in 2024. Here’s how their income will be taxed under the kiddie tax rules:
- The first $1,300 of their unearned income is tax-free.
- The next $1,300 is taxed at the 16-year-old's own tax rate, which, for example, could be 10%, resulting in a $130 tax on this portion.
- The remaining $1,400 ($4,000 – $2,600) will be taxed at the parents' marginal tax rate. If the parents are in the 32% tax bracket, the $1,400 will be taxed at 32%, resulting in $448 of additional tax.
In this case, the 16-year-old would pay $130 in taxes at their own rate and $448 at the parents' rate, for a total tax of $578 on her $4,000 of unearned income.
Reporting and Paying the Kiddie Tax
To report and pay the kiddie tax, parents can choose between two methods:
- Have the child file their own tax return. If the child's unearned income is more than $2,600 in 2024, the child must file their own tax return using IRS Form 8615, "Tax for Certain Children Who Have Unearned Income." This form calculates the amount of tax owed at the parents' higher marginal rate for income above the threshold.
- Include the child’s unearned income in their tax return. Alternatively, if the child's gross income is less than $13,000 in 2024, parents may elect to include the child's unearned income on their own tax return using IRS Form 8814, "Parents’ Election to Report Child’s Interest and Dividends." This method can simplify the process but may increase the parents' taxable income.
In both cases, the tax must be paid by the filing deadline, typically April 15, to avoid penalties or interest on unpaid taxes.
How to Avoid the Kiddie Tax
While the kiddie tax is designed to prevent families from shifting investment income to their children to take advantage of lower tax rates, there are strategies that can help minimize or avoid it.
One approach is to manage the child's unearned income to stay below the annual threshold. For example, by limiting the amount of income-generating investments that produce dividends and interest, parents can keep their child's income remains under $2,600 in 2024, avoiding the kiddie tax altogether.
Another strategy is to prioritize investments that generate little or no taxable income. For example, investing in growth-oriented stocks that focus on capital appreciation rather than dividend payouts, or utilizing tax-efficient investments such as tax-free municipal bonds, can reduce unearned income. Additionally, families can invest through tax-advantaged accounts like 529 college savings plans or Roth IRAs (if the child has earned income), where the earnings grow tax-free or are subject to more favorable tax treatment.
Parents can also encourage their children to earn their own income. Since earned income is taxed at the child's rate and not subject to the kiddie tax, having a job or side business can reduce the proportion of a child’s income that comes from investments.
Bottom Line
The kiddie tax helps prevent families from reducing their taxes by shifting investment income to children. It primarily applies to unearned income, such as dividends and interest, for children who are under 18 and full-time students under 24 who rely on parental support. Unearned income exceeding annual thresholds is taxed at the parents' marginal rate, making it harder to use a child's lower tax bracket as a loophole. Using tax-advantaged accounts, prioritizing growth-focused investments and encouraging earned income can reduce or avoid the kiddie tax.
Tax Planning Tips
- A financial advisor can help you develop a tax strategy that aims to reduce your liability. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much you could pay in taxes for the sale on an investment, SmartAsset's capital gains calculator could help you get an estimate.
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