Kiddie Tax

As a parent or guardian, you may be surprised to learn that your child’s unearned income could be subject to taxes, thanks to the Kiddie Tax. The Kiddie Tax is a set of rules established by the IRS to prevent parents from shifting income to their children in order to take advantage of lower tax rates. While this may seem like an obscure tax concept, understanding how it works is crucial to effectively managing your family’s tax situation.

In this article, we will break down what Kiddie Tax is, the rules that govern it, how it affects your taxes, and tips for minimizing its impact.

What is Kiddie Tax?

The Kiddie Tax refers to taxes that are applied to a child’s unearned income. Unearned income includes income such as interest, dividends, capital gains, and other forms of investment income, rather than wages from a job. The tax was introduced in the 1980s to curb the practice of parents shifting investment income to their children’s names in order to take advantage of the lower tax brackets typically available to children.

Under the Kiddie Tax rules, children under the age of 19 (or 24 if they are full-time students) are taxed at their parents’ tax rate on unearned income that exceeds a certain threshold. This means that, in some cases, children with significant unearned income may end up paying taxes at the parents’ higher tax rates rather than their own, which are typically lower.

Kiddie Tax Rules and Thresholds

The IRS has specific guidelines that dictate when the Kiddie Tax applies. Here’s an overview of the rules:

1. Age Requirement
   The Kiddie Tax generally applies to children under the age of 19. However, if the child is a full-time student, the age requirement extends to 24. The child must be under these age limits and must not be married and filing a joint tax return in order for the Kiddie Tax to apply.

2. Unearned Income Threshold
   The tax only applies to unearned income that exceeds a certain threshold. For the tax year 2024, the first $2,300 of a child’s unearned income is generally not subject to the Kiddie Tax. However, any unearned income over this amount is taxed at the parent’s tax rate, not the child’s lower tax rate.

3. Unearned Income Types
   Unearned income includes earnings from investments, such as:

   • Interest income from savings accounts or bonds
   • Dividend income from stocks
   • Capital gains from the sale of investments
   • Rental income (if the child owns property)

   Earned income, such as wages from a part-time job, is not subject to the Kiddie Tax and is taxed at the child’s tax rate.

4. Tax Filing Requirements
   If the child has unearned income exceeding $2,300 (for 2024), the child must file their own tax return. The child’s unearned income is reported on Form 8615, and the tax is calculated based on the parent’s tax bracket. This form is used to calculate how much of the unearned income is taxed at the parent’s tax rate.

How Kiddie Tax Affects Your Family’s Taxes

The Kiddie Tax rules can significantly impact a family’s overall tax burden, especially if a child has substantial unearned income. If the child’s unearned income exceeds the threshold, the additional tax liability will be calculated based on the parent’s tax rate, which could be much higher than the child’s tax rate.

Example of Kiddie Tax:

Let’s say a child under 19 has $5,000 in unearned income, consisting of dividends and interest. The first $2,300 is taxed at the child’s tax rate, which is likely to be zero or a lower rate. However, the remaining $2,700 of unearned income will be taxed at the parent’s tax rate. If the parent is in the 24% tax bracket, the child’s remaining $2,700 of income would be taxed at that rate, leading to an additional tax liability of $648.

Minimizing the Impact of Kiddie Tax

While the Kiddie Tax is unavoidable in some cases, there are strategies you can use to minimize its impact on your family’s finances:

1. Shift Income to Tax-Advantaged Accounts
   One of the best ways to avoid triggering the Kiddie Tax is to invest children’s money in tax-advantaged accounts like 529 college savings plans or custodial IRAs. Earnings in these accounts are often tax-deferred or may be excluded from taxable income, depending on the account and its purpose.

2. Consider Gifts and Family Loans
   Instead of giving children large sums of unearned income, you might want to consider giving assets to family members who are not subject to the Kiddie Tax, such as older relatives. Additionally, structuring family loans that generate interest could help minimize the tax liability by redistributing the income.

3. Tax-Efficient Investments
   Invest in tax-efficient assets such as municipal bonds, which are exempt from federal income tax, or consider capital gain-focused investments, as capital gains may be taxed more favorably than interest and dividends.

4. Use the Standard Deduction
   If the child has earned income (such as a part-time job), make sure they take full advantage of the standard deduction, which, for 2024, is $13,850 for a single filer. This could reduce the total taxable income, reducing the need for filing additional tax returns or triggering higher Kiddie Tax rates.

5. Donate to Charity
   If the child has significant unearned income, consider contributing some of the funds to a qualified charitable organization. Charitable donations could potentially reduce the taxable income, although this requires proper planning to ensure the deductions align with the child’s financial situation.