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The Kiddie Tax: What You Need to Know

What is the kiddie tax and what role does it play in estate planning? Trust & Will explains what you need to know about the kiddie tax.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

If you have any children, you need to know about the kiddie tax. You may find this hard to believe (or perhaps easy to believe), but there is a tax levied on children. However, don’t worry. This is not a blanket tax policy that impacts all children. Rather, this tax is specifically for children who own any income-producing assets. The tax law doesn’t aim to take money away from children. Rather, it’s there to prevent parents from exploiting tax loopholes. Keep reading to find out more about the kiddie tax, how it works, and everything you need to know. 

What is Kiddie Tax?

The kiddie tax is a tax that is levied on any income-generating assets owned by children. For example, this could be any income earned from investments held in a custodial account. Other examples include inherited retirement accounts or taxable scholarships. In other words, these are taxes on a child’s unearned income.

The kiddie tax law was passed as a way to prevent wealthy individuals from avoiding taxes. Before the kiddie tax law was passed, some parents would transfer large gifts of stocks and other investments to their children. That way, they could avoid paying high income tax rates. 

How Does the Kiddie Tax Work?

The kiddie tax has been revised numerous times, but most recently in 2022, any unearned income under $1,100 qualifies for the standard deduction. The next $1,100 is taxed at the child’s tax rate, which is very low. At times, it may be as low as 0 percent. Parents with children who own assets that produce less than $2,200 in income each year have very little to worry about. However, any unearned income over $2,200 is taxed at the parent’s income tax rate, which can be as high as 37 percent. 

What Are the Kiddie Tax Rules?

The rules for the kiddie tax depend on how much the child earned between earned and unearned income. Children who earn more than $12,400 in total must file their own income tax return. 

If that income only came from unearned income (investment interest, dividends, and capital gains distributions) and is valued under $11,000 then the parents or guardians may be permitted to include this income in their own tax return. They must file a Form 8814 to do so. 

Here is an at-a-glance summary of the kiddie tax rules:

  • Kiddie taxes apply to children aged 18 and under

  • The tax may also apply to any dependent children aged 19 through 24 if they are full-time students, unless they are married and are filing taxes jointly 

  • The first $1,100 of unearned income is not taxed

  • The next $1,100 of unearned income is traded at the child’s income tax rate (could be as low as 0%)

  • Anything over $2,200 is taxed at the parent’s income tax rate

  • Children may be required to file their own income tax returns if they also have earned income in addition to unearned income

Who Does the Kiddie Tax Apply To?

The kiddie tax currently applies to all children who are aged 18 and under. The tax also applies to any dependent full-time students between the ages of 19 and 24. However, for any that child is married and files their taxes jointly, the kiddie tax is not applied. Therefore, the parents of any children subject to the kiddie tax are also impacted. 

Do I Have to Pay Kiddie Tax?

Whether or not you have to pay the kiddie tax largely depends on your personal circumstances. If you are 18 years old or younger, and own any income-producing assets, then you may have to pay the kiddie tax. This is also true if you’re between the ages of 19 to 24, are a full-time student, and your parents claim you as a dependent for income tax purposes. 

However, you’re typically only subject to the kiddie tax if your unearned income in a year exceeded $1,100. However, your tax rate may be 0 percent (or close to nothing) as long as you gained less than $2,200. If you made anything over $2,200, the Internal Revenue Service will assess the kiddie tax at your parents’ income tax rate. Your parents may be allowed to include your unearned income in their income tax return and therefore pay your kiddie tax for you.

How Do I Avoid Kiddie Tax?

You may be able to avoid the kiddie tax if you plan ahead. Minimizing the taxes you owe is perfectly legal, and requires some financial planning. 

The first option is to keep your child’s investment income low. As long as their unearned income is under $1,100, they won’t be subject to taxes. Even if they exceed $1,100, their tax rate could be negligibly low, until they hit $2,200.

You could also consider setting up a college savings plan for your child. Although the contributions themselves won’t give you a tax deduction, any money taken out to pay for college is exempt from income taxes. 

Last but not least, consider setting up a Roth IRA. If your child earns any income, they can contribute to this type of retirement account. Later on, when your child withdraws money from their Roth IRA in retirement, the money doesn’t get taxed. If you like this option, you could encourage your child to invest in a Roth IRA over any other type of income-producing asset that would be subject to the kiddie tax. 

Protect Your Children by Getting Your Estate Plan in Order Today

When setting up your Estate Plan, you may consider giving generous gifts to your children. As of today, you were made aware that certain income-producing gifts could make your child subject to the kiddie tax

Again, the kiddie tax is imposed on any child who makes any unearned income over $1,100. This could be from dividends and other earned interest from investments held in custodial accounts. If the amount is over $2,200 then their tax rate could be as high as yours! However, this isn’t necessarily a bad thing. As adults, we are taxed on our income (earned or unearned). This is a fact of life that is often unavoidable. If your child has the privilege of owning income-producing assets early on in life, perhaps it could be a healthy life lesson and financial planning training for them. 

This is also an important reminder to craft your Estate Plan carefully. Your intention could be good and pure, but you may unknowingly cause unexpected ripple effects. Your beneficiaries may be subject to certain inheritance taxes based on what you decide to give them. Instead of gifting stocks and other investments to your underaged child, consider placing and protecting assets in a Trust. This is a fiduciary account that allows assets to grow over time. Later in life, when your child is an adult, the Trust can distribute funds to them per your terms. 

To find out more about Trusts and other estate planning options, get started today!

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