Before the Kiddie Tax, parents could save on taxes by putting investment accounts in a child’s name. Parents would gift stocks and other assets to their children, and income earned on the assets would be taxed at the child’s (lower) income tax rate, instead of the parent’s (higher) income tax rate. The Kiddie Tax closed this loophole by taxing children’s passive income at higher rates.
History of the Kiddie Tax
The Kiddie Tax was created as part of the Tax Reform Act of 1986 and was recently updated by the Tax Cuts and Jobs Act of 2017. Prior to the changes, a portion of a child’s unearned income qualified for the standard deduction, a portion was taxed at the child’s income tax rate and unearned income above a certain threshold was taxed at the parent’s marginal tax rate.
In 2019 a dependent child’s unearned income above $2,200 is taxed at the rates that apply to trusts and estates, which makes the Kiddie Tax more expensive for some families. However, these changes are set to expire beginning in 2026. Pending legislation, such as the SECURE Act, proposes to revert the Kiddie Tax to the old rules, in part because of the impact on Gold Star families and scholarships.
How does the Kiddie Tax work?
The Kiddie Tax applies to dependent children who are younger than 19 years old, or who are full-time students who are between the ages of 19 and 23. An exception to the Kiddie Tax is a child with earned income totaling more than half the cost of their support. Another exception is for children who file tax returns as married filing jointly. Income from wages, salary, tips or self-employment is not subject to the Kiddie Tax.
A child’s unearned income may include:
- Taxable interest
- Capital gains
- Taxable scholarships
- Income produced by gifts from grandparents
- Income produced by custodial accounts under the Uniform Gifts to Minors Act (UGMA)
How to calculate the Kiddie Tax
To calculate the Kiddie Tax, first determine the child’s taxable income:
Child’s Net Earned Income + Child’s Net Unearned Income – Child’s Standard Deduction = Child’s Taxable Income
The child’s earned income is taxed at their normal rate, and unearned income above $2,200 is taxed at the rates that apply to trusts and estates.
In 2019, a child’s standard deduction amount is the greater of $1,100, or the sum of $350 plus the child’s earned income, if the child can be claimed as a dependent. Otherwise, the standard deduction for a single filer is $12,000.
For example, if a dependent child has no earned income and $3,500 of unearned income, $1,300 would be subject to the Kiddie Tax, at a rate of 10%.
$0 (Earned Income) + $3,500 (Unearned Income) - $1,100 (Standard Deduction) = $2,400 (Taxable income)
$3,500 (Unearned Income) -$2,200 (kiddie tax threshold) = $1,300 (Net Unearned Income)
$2,400 (Taxable Income) - $1,300 (Net Unearned Income) = $1,100 (Earned Taxable Income)
2019 Tax Brackets for Estates and Trusts
$0 to $2,600
10% of taxable income
$2,601 to $9,300
$260 plus 24% of the amount over $2,600
$9,301 to $12,750
$1,868 plus 35% of the amount over $9,300
$3,075.50 plus 37% of the amount over $12,750
Families who have unearned income that is subject to the Kiddie Tax must file IRS Form 8615 with their federal tax return. A separate tax return must be filed for children who have unearned income that is greater than $11,000 or any amount of earned income. If a child’s unearned income is less than $11,000 and greater than $1,100, the child’s unearned income can be included on their parents’ income tax return.
Are 529 plan earnings subject to the Kiddie Tax?
Interest earned on 529 plans and custodial 529 plan accounts is not subject to the Kiddie Tax. 529 plans are investment accounts designed to help individuals save for college. Contributions are made with after-tax dollars, and any interest earned on the investment grows tax-deferred. Distributions are completely tax-free when the funds are used to pay for qualified higher education expenses.
Investment earnings in other custodial accounts, however, are subject to the Kiddie Tax. Custodial accounts used for college savings may be converted to custodial 529 plan accounts to take advantage of the tax benefits. Savings held in a custodial 529 plan account also have less of an impact on a student’s need-based financial aid eligibility than traditional custodial accounts.