A tax provision commonly called the “kiddie tax” can cause a child’s unearned income to be taxed at the parent’s tax rates – often considerably higher than the much lower rates a child would otherwise pay.
The rules are complicated and can impact individuals up to age 23, often catching families by surprise.
Kiddie tax basics
Perhaps the most important thing to know about this poorly understood provision is that, for a student, the kiddie tax can be an issue until the year that he or she turns age 24. For that year and future years, your child is finally kiddie-tax-exempt.
The kiddie tax is only assessed on a child’s (or young adult’s) unearned income. That usually means interest, dividends, and capital gains. These types of income often come from custodial accounts that parents and grandparents set up and fund for younger children.
Earned income from a job or self-employment is never subject to the kiddie tax.
Calculating the tax
To determine the kiddie tax, first add up the child’s (or young adult’s) net earned income and net unearned income. Then subtract the allowable standard deduction to arrive at the child’s taxable income.
The portion of taxable income that consists of net earned income is taxed at the regular federal income tax rates for single taxpayers.
The portion of taxable income that consists of net unearned income that exceeds the standard deduction ($2,600 for 2024 or $2,500 for 2023) is subject to the kiddie tax and is taxed at the parent’s higher marginal federal income tax rates.
The tax is calculated by completing an IRS form, which is then filed with the child’s Form 1040.
Calculating and reporting the kiddie tax can be cumbersome and complicated, often requiring help from an accounting professional.
Is your child exposed?
For 2023, the relevant IRS form must be filed for any child or young adult who meets each of these criteria:
- Has more than $2,500 of unearned income
- Is required to file a Form 1040
- Is under age 18 as of December 31, 2023; or is age 18 and didn’t have earned income more than half of his or her support; or is between ages 19 and 23 and a full-time student and didn’t have earned income more than half of his or her support
- Has at least one living parent
- Didn’t file a joint return for the year
For 2024, the same rules apply, except the unearned income threshold is raised to $2,600.
Don’t let the tax sneak up on you
There are strategies to minimize or avoid the tax. For example, your child could invest in growth stocks that pay no or minimal dividends and hold on to them until a year when the kiddie tax no longer applies.
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