By Dr. Jim Dahle, WCI Founder

The “kiddie tax” is not a separate tax you've never heard of; it is just regular old income tax. What the kiddie tax refers to is simply the closure of a loophole to prevent you from shifting too much unearned income to your minor children to lower the total family tax bill. Let's talk about it some more today.

 

How Does the Kiddie Tax Work?

This subject should really be called the child income tax loophole. All the kiddie tax does is put a limit on how much income you can run through this loophole. When your children have unearned income, typically in a Uniform Gift to Minors Account (UGMA) or Uniform Transfer to Minors Account (UTMA), some of the income is tax-free, some of the income is taxed at the minor's tax rate, and the rest is taxed at the parent's rate. The tax paid for by the income taxed at the parent's rate is unaffectionately called the “kiddie tax.”

In 2024, the first $1,300 of unearned income for a child is taxed at 0%. The next $1,300 of unearned income for a child is taxed at their tax bracket (generally 0% for qualified dividends and long-term capital gains and 10% for other income). Thus, the “kiddie tax threshold” in 2024 is $2,600. This number is indexed to inflation, and it tends to increase each year. Keep in mind it is entirely possible for that income to be taxed at 0%—for example, if the income is qualified dividends and the parents are in the 0% qualified dividend bracket.

 

Why Does the Kiddie Tax Exist?

The kiddie tax exists so that a parent does not give a minor child a lot of assets JUST to save the family a lot of taxes on the income associated with those assets.

 

What Income Is Subject to the Kiddie Tax? (Earned vs. Unearned Income)

Only unearned income is subject to the kiddie tax—such as interest, dividends, rents, royalties, taxable scholarships, pension income, annuity income, and capital gains. If they earn income at a job, from a household employer (think babysitting or mowing lawns in the neighborhood), or through self-employment, it's never subject to the kiddie tax. Earned income is always paid at the child's tax rate, usually 0%.

More information here:

12 Things I Learned From Doing My Own Taxes as a Kid

 

When Does the Kiddie Tax Apply?

The kiddie tax applies to every dollar of unearned income beyond $2,600 per year in 2024. While the final tax bill for each year is due on or near April 15, our tax system is a pay-as-you-go system. If the child has so much unearned income that the kiddie tax due on it pushes the child out of the safe harbor, the child should start making quarterly estimated payments to cover that income.

 

What Is the Age Limit for the Kiddie Tax?

Kiddie taxes go away for dependents either for the tax year in which they turn 19 or, for full-time students, the tax year in which they turn 24. Here are the technical rules from the IRS instructions for Form 8615 for 2023. Note that for 2024, the limit is $2,600.

Form 8615 must be filed for any child who meets all of the following conditions.

  1. The child had more than [$2,600] of unearned income.
  2. The child is required to file a tax return.
  3. The child either:
    • Was under age 18 at the end of 2023,
    • Was age 18 at the end of 2023 and didn’t have earned income that was more than half of the child's support, or
    • Was a full-time student at least age 19 and under age 24 at the end of 2023 and didn’t have earned income that was more than half of the child's support. (Earned income is defined later. Support is defined below.)
  4. At least one of the child's parents was alive at the end of 2023.
  5. The child doesn’t file a joint return for 2023.

For these rules, the term “child” includes a legally adopted child and a stepchild. These rules apply whether or not the child is a dependent. These rules don’t apply if neither of the child’s parents were living at the end of the year.

More information here:

How to Hire Your Kids for Taxes the Right Way

 

What If the Child Is Not Your Dependent?

If the child is not a dependent, there is no kiddie tax. All of their unearned income is taxed at their own tax rates. If the child is a dependent but not your dependent, you also do not pay the kiddie tax.

 

What Is the Kiddie Tax Rate?

kiddie tax

The kiddie tax rate is variable, ranging from 0%-37%, not including state tax. It is simply the parent's marginal tax rate. For 2024, the tax rates on the child's income will fall into these ranges:

  • First $1,300: 0%
  • $1,301-$2,600: 0%-10%
  • Above $2,600 (kiddie tax): 0%-37% depending on the parent's tax bracket

 

Who Is Subject to Kiddie Tax?

The parent of a dependent child under 18 or a full-time student under 24 if that child has more income than the kiddie tax income threshold ($2,600 in 2024) will be subject to kiddie tax.

More information here:

How to Open a Roth IRA for Your Kids (and Should You)?

My Children’s Inheritance

 

How to Calculate the Kiddie Tax?

For simple ballpark estimates, simply multiply the amount of income the child has above $2,600 by the parent's marginal tax rate for that type of income. For formal calculation, use tax Form 8615 or tax software.

 

How Is the Kiddie Tax Reported?

The kiddie tax is reported on IRS Form 8615. It is a one-page, 18-line form filed with the child's tax return that looks like this:

 

IRS Form 8615

 

Many people will never get past line 3 on this form because they don't owe kiddie tax. The rest of the form is basically just a math problem calculating the kiddie tax due. Note that lines 6, 9, and 10 must come from the parent's tax return, so the parental return has to be done before a child's return where kiddie tax is owed can be completed. If the parent has to file an extension, so does the child.

 

Does My Child Need to File Their Own Tax Return?

Whether a return needs to be filed on behalf of a child depends on the types and amounts of income they have. The rules are found in the instructions for IRS Form 1040. Keep in mind that you CAN file a tax return even if it's not required. This can be useful to establish an income for a student loan Income Driven Repayment (IDR) program (especially useful as a fourth-year medical student for the tax year in which you started your fourth year). Filing can also be useful to get back withheld taxes as a tax refund.

 

Do Your Kids Need to File Taxes?

 

Basically, if the dependent has unearned income over $1,300 in 2024, they have to file a return (whether any tax is due or not). If their earned income was more than the standard deduction ($14,600), you also have to file. However, there is a third rule which is slightly more complicated. If your gross income is more than the larger of $1,250 or your earned income plus $400, you also have to file. That third rule has been the cause of my kids having to file in the past. Sometimes they haven't actually owed federal income tax, but the fact that they had to file a federal return resulted in them having to file a state return, where they did owe income tax.

However, just because a child has to file a return DOES NOT mean the child has to file a return separate from the parental return. As IRS Topic 553 says:

 

Does a Child Have to File a Separate Return

 

The rules are basically that if the child is under 19 (or 24 if a full-time student), has no earned income, and does not have more than $12,500 in unearned income, you can file Form 8814 on your tax return instead of having them do a separate one. Frankly, I prefer filing their tax returns. I can do four of them in about an hour, but I usually get them involved in doing it so it takes a little longer. So far, I haven't had to file Form 8615 with their returns (see the next section for the strategies used), but that is likely to change for tax year 2024. At any rate, if you don't want to do a separate return and qualify not to, expect to see Form 8814 on your tax return.

 

IRS Form 8814

 

Doesn't look too bad, only 15 lines. Probably easier than filing separate returns.

 

What Strategies Can Be Used to Minimize Kiddie Tax?

My children have substantial amounts of money, including UTMA accounts. At least through tax year 2023, we've never had to pay any kiddie tax. How did we do that? There are a few strategies.

 

#1 Invest Preferentially in Tax-Protected Accounts

Just like adults, kids should also invest in tax-protected accounts preferentially. These accounts minimize taxation (and thus grow faster without that tax drag), facilitate estate planning, and provide additional asset protection in many states. In the case of my children, these accounts include a 529 account for each of them (technically these accounts belong to me) and a Roth IRA for each of them. If you're saving money for college, use a 529 account instead of a UTMA to avoid the kiddie tax. If they have earned income, use a Roth IRA instead of a UTMA to avoid the kiddie tax.

 

#2 Invest Tax-Efficiently

The same principles that apply in your taxable account apply to your child's taxable account; that's what a UTMA is. Use low-turnover, broadly diversified, low-cost index funds. Funds like the Vanguard Total Stock Market Index Fund (VTSAX) have not distributed capital gains for decades. The dividend yield is relatively low, and it almost completely consists of qualified dividends. Don't buy and sell unnecessarily, triggering capital gains. Take advantage of the foreign tax credit and possibly even some tax-loss harvesting.

 

#3 Keep Your UTMA to a 5-Figure Amount

If you're investing tax-efficiently, you're unlikely to end up with a kiddie tax problem before the UTMA hits six figures. The current yield on VTSAX as I type this is 1.35%.

1.35% * $100,000 = $1,350, well below the $2,600 kiddie tax threshold. In fact, you can have almost $200,000 in there before kiddie tax will be owed on its income. You could find an even more tax-efficient investment, such as Berkshire-Hathaway stock, Bitcoin, or a rental property with lots of depreciation. But be careful not to let the tax tail wag the investment dog. If the UTMA is getting too large, you could even spend some of it. Just remember it has to be spent on the child. But most parents spend plenty of money on their children every year, so that shouldn't be a difficult limitation to get around.

 

Kiddie tax isn't a separate tax; it is just income tax. To prevent parents from shifting too much income to their kids, income above a certain threshold is taxed at the parent's tax rate. Knowing that the kiddie tax exists, though, could compel you to try to make sure you don't have to pay much or any of it.

 

If you need help with tax preparation or you’re looking for tips on the best tax strategies, hire a WCI-vetted professional to help you figure it out.

 

What do you think? Do you pay kiddie tax? What have you done to minimize it? Comment below!