Kiddie tax
A rule that taxes a child’s investment income above a yearly threshold at the parents’ tax rate instead of the child’s lower rate.
What it means
The kiddie tax exists to stop families from shifting investments into a child’s name to get lower tax rates. It applies to unearned income, such as interest, dividends and capital gains, above a threshold the IRS adjusts each year. A small amount is tax-free, a second slice is taxed at the child’s rate, and the rest is taxed at the parents’ marginal rate.
It generally covers children under 18, plus 18-year-olds and full-time students ages 19 to 23 whose earned income does not exceed half of their own support. A child’s wages from a job are not affected. In some cases parents can elect to report the child’s income on their own return instead of filing for the child.
Example
Suppose a child earns $5,000 of interest and dividends, and $3,000 of it is above the year’s kiddie tax threshold. At a hypothetical parental rate of 32%, tax on that $3,000 is $960, compared with $300 at a hypothetical 10% child rate.
How it’s used
- Holding investments in custodial accounts for children
- Gifting appreciated stock to a child
- Planning for a student’s investment income
Good to know
- Investments in a 529 plan grow without current tax, so they do not generate kiddie tax income.
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.