Kiddie Tax: What It Is, How It Works, and When It Applies

What Is the Kiddie Tax?

The kiddie tax is a tax imposed on income unrelated to employment earned by individuals 18 years of age or under—or dependent full-time students under age 24. Introduced as part of the Tax Reform Act of 1986, it is designed to stop parents from registering investments in their children’s name to avoid paying taxes.

The kiddie tax threshold adjusts each year for inflation. In 2023, unearned income surpassing $1,250 is subject to the child’s tax rate, and anything above $2,500 is taxed at the guardian’s tax rate.

How the Kiddie Tax Works

The kiddie tax is imposed on individuals under a certain age whose investment and unearned income is higher than an annually determined threshold. It applies to all children aged 18 and under at the end of the tax year as well as children who are dependent full-time students between the ages of 19 and 24.

This rule is designed to prevent parents from exploiting a tax loophole where their children are given large gifts of stock. In this case, the child would then realize any gains from the investments and would be taxed at a far lower rate compared to the rate the guardians face for their realized stock gains.

The kiddie tax includes unearned income a child receives: interest, dividends, capital gains, rent, and royalties. Any salary or wages the child earns is not subject to the kiddie tax.

What Is the Kiddie Tax Rate for 2023?

Under the kiddie tax law, all unearned income over the threshold is taxed at the parent's marginal income tax rate rather than the child's tax rate.

In the 2023 tax year, unearned income under $1,250 qualifies for the standard deduction. The next $1,250 is taxed at the child's tax rate, which is very low—sometimes 0%—and then anything over is taxed at the guardian's tax rate, which could be as high as 37%.

How Is Kiddie Tax Reported?

There are generally two ways to go about reporting a child’s unearned income.

1. The parent reports a child's interest, ordinary dividends, and capital gains distributions alongside their own tax return on Form 8814 (Parent’s Election to Report Child’s Interest and Dividends)
2. The child reports it on Form 8615 (Tax for Certain Children Who Have Unearned Income), which is attached to the child’s Form 1040

The first option can be used when the child’s only income is interest and dividend income, including capital gains, and totals less than $11,000. If that’s not the case, the second route will have to be taken, presumably with the help of the parent.

History of the Kiddie Tax

The tax law originally only covered children under 14 years of age. Children under the age of 14 cannot legally work, which means that any income they received usually came from dividends or interest from bonds. However, the tax authorities realized that some guardians would take advantage of the situation and then give stock gifts to their older, 16-to-18-year-old children.

The Tax Cuts and Jobs Act of 2017 temporarily changed the kiddie tax to use the tax rates that apply to estates and trusts rather than the tax rate of the child's parents. However, the Further Consolidated Appropriations Act 2020 retroactively changed it back to the parent's tax rate. For 2018 and 2019 returns, taxpayers could use either the estate tax rates or the parent's take rate for calculating the kiddie tax. For 2020 and beyond, the parent's tax rate applies.

The Bottom Line

The kiddie tax, a tax imposed on individuals under a certain age whose unearned income is higher than an annually determined threshold, is designed to put an end to an old tax loophole and is something parents need to be aware of.

If you are investing on behalf of a child, consider speaking to a financial advisor or tax advisor. Firstly, it’s important to be aware of the rules and your obligations. And secondly, there are ways to limit and/or avoid this liability.