Do You Understand the Kiddie Tax?

Are your children generating unearned income from assets in a custodial account? If so, you need to be familiar with what’s called the “kiddie tax.” 

This law, passed in 1986, was created to discourage wealthy individuals from transferring assets to their children to take advantage of their lower tax rates. 

Today, the law taxes a minor child’s unearned income – which includes capital gains distributions, dividends, and interest income – at the parents’ tax rate if it exceeds the annual limit, which is now $2,200 in 2021.

How the Kiddie Tax Works

The kiddie tax applies to dependent children under the age of 18 and full-time students under the age of 24 at the end of the tax year and works like this: 

  • The first $1,100 of unearned income is covered by the kiddie tax’s standard deduction, so it isn’t taxed.
  • The next $1,100 is taxed at the child’s marginal tax rate.
  • Anything above $2,200 is taxed at the parents’ marginal tax rate.

If your child also has earned income from a part-time or seasonal job, the rules become more complicated. To learn more, see IRS Publication 929 or contact our office.

Here’s an example of how the kiddie tax could hurt your loved ones, not help them. 

  • A well-meaning Grandpa sets up a custodial account for his 16-year-old granddaughter. 
  • Grandpa does a little stock trading in that account and generates $8,000 in unearned income. 
  • His granddaughter, who earned $2,500 as a part-time lifeguard making minimum wage for the summer, now has to pay taxes on that $8,000 – at her parent’s tax rate!

Thanks a lot, Grandpa!

If you manage custodial accounts for a minor, be sure you understand the impacts of unearned income in those accounts. If you’re focused on growth, great. Just be prepared to help communicate with and support your child or beneficiary on the tax front.

The Tax Cuts and Jobs Act of 2017 effectively raised one kiddie tax by basing it on the tax rates used for estates and trusts instead of the rates used for parents. That change has since been repealed. So, if your family paid the kiddie tax in 2018 or 2019, you could be eligible for a refund.

Contact us today to determine whether the potential refund is worth the paperwork. We can help you make the right decision for your family. 

Share this Post:

Subscribe Now – Free!

Terms and Conditions checkbox is required.
Something went wrong. Please check your entries and try again.