Kiddie Tax

Kiddie Tax Basics

Under the Kiddie Tax rules, a portion of a child’s net unearned income is taxed at the parents’ federal marginal tax rate. The key point to understand is that when the Kiddie Tax applies, part of the child’s net unearned income may be subject to a higher federal income tax rate than it would otherwise be. [See IRC Section 1(g) and former IRC Section 1(j)(4).]

The Kiddie Tax applies only to the portion of a child’s net unearned income that exceeds the annual threshold amount ($2,600 for 2024). If the child’s annual net unearned income does not exceed the threshold, the Kiddie Tax does not apply for that year. If the net unearned income exceeds the threshold, only the excess is subject to the Kiddie Tax. “Unearned income” means all income other than wages, salaries, professional fees, or compensation for personal services. Thus, capital gains, dividends, and interest are considered unearned income. Earned income (from employment or self-employment) is never subject to the Kiddie Tax.

Is the Child Subject to the Kiddie Tax or Exempt?

The Kiddie Tax can apply until the year in which a dependent child reaches age 24. In other words, it does not apply to individuals who are 24 or older at the end of the year. For those aged 19–23 at year-end, they must be full-time students for the Kiddie Tax to apply. Generally, children under 19 with significant unearned income are subject to the Kiddie Tax.

A dependent child means a child who would have qualified as a dependent under prior law, which generally requires that the parents provide more than half of the child’s support.

In summary, the Kiddie Tax applies only when all four of the following conditions are met:

1. The child does not file a joint return for the year.

2. At least one parent of the child is alive at the end of the year.

3. The child’s net unearned income exceeds the threshold amount and results in taxable income after subtracting the standard deduction. For 2024, the threshold amount is $2,600, adjusted annually for inflation. If the income does not exceed the threshold, the Kiddie Tax does not apply.

4. The child meets one of the following age tests:

5. Age Test 1 (Under 18 at year-end): Kiddie Tax applies if the other conditions are met.

6. Age Test 2 (18 at year-end): Kiddie Tax applies if the child’s earned income does not exceed half of their total support and the other conditions are met.

7. Age Test 3 (Age 19–23 at year-end, and a student): Kiddie Tax applies if the child is a full-time student, and earned income does not exceed half of their total support, provided the other conditions are met. A student is defined as someone enrolled in a qualified educational institution for at least five months during the year.

Examples

• Example 1: As of December 31, 2024, the grandson is 17. He meets Age Test 1, and if the other three conditions are satisfied, the Kiddie Tax applies.

• Example 2: As of December 31, 2024, the granddaughter is 19, a student, and her earned income does not exceed half of her support. She meets Age Test 3, so if the other conditions are met, the Kiddie Tax applies.

• Example 3: As of December 31, 2024, the granddaughter is 21 and graduated from college in May 2024 but is unemployed. She was a full-time student for the first five months of 2024 and had minimal earned income. She meets Age Test 3, and thus the Kiddie Tax applies for 2024. However, since she graduated, she will not be subject to the Kiddie Tax after 2025.

  
  

Variation: If the granddaughter obtained employment in June 2024 and covered more than half of her support with earned income, Age Test 3 would not apply, and the Kiddie Tax would not apply.

How to Calculate the Kiddie Tax

To compute federal income tax for a child subject to the Kiddie Tax, add together the child’s net earned and net unearned income. Subtract the standard deduction to determine taxable income.

For 2024, the standard deduction is the greater of:

• $1,300, or

• Earned income + $450, limited to $14,600. [Rev. Proc. 2023-34]

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The portion of taxable income attributable to earned income is taxed using the Single taxpayer rates. If net unearned income exceeds the threshold ($2,600 for 2024), the excess is subject to the Kiddie Tax.

Key Point: The Kiddie Tax is computed on Form 8615 (Tax for Certain Children Who Have Unearned Income).

Example 4: Kiddie Tax Does Not Apply – Unearned Income Below Threshold

In 2024, Fritz (age 17) earned $2,000 of wages from his parents’ business and had $2,300 of interest income. Since $2,300 does not exceed the $2,600 threshold, the Kiddie Tax does not apply. His taxable income is $1,850 ($4,300 total income – $2,450 standard deduction). This is taxed at 10%, resulting in $185 of tax.

Variation: If the $2,300 were entirely long-term capital gains (LTCG), then $2,000 of earned income plus $450 of LTCG would be offset by the $2,450 standard deduction. The remaining $1,850 LTCG would be taxed at 0% for a Single taxpayer, resulting in no tax.

Example 5: Child with Significant Unearned Income – Kiddie Tax Increases Liability

In 2024, Gina (age 17) had $2,000 of earned income and $25,000 of interest and short-term capital gains. With a $2,450 standard deduction, taxable income is $24,550.

• $25,000 – $2,600 = $22,400 is subject to Kiddie Tax at the parents’ 32% rate = $7,168.

• The remaining $2,150 is taxed at 10% = $215.

Total Tax = $7,383 ($7,168 + $215).

Key Point: Without the Kiddie Tax, Gina’s tax would have been only $2,714 ([$11,600 × 10%] + [$12,950 × 12%]). Thus, the Kiddie Tax can be very costly for children with significant unearned income.

Planning to Avoid the Kiddie Tax

Fortunately, there are strategies to partially or fully avoid the Kiddie Tax.

Use the Unearned Income Threshold

The Kiddie Tax applies only if a child’s unearned income exceeds the threshold for the year. For 2024, the threshold is $2,600, adjusted annually for inflation. This provides an opportunity for planning.

• Example 6: If a child (age 20, full-time college student, dependent of the parents) has only $2,450 of unearned investment income, the Kiddie Tax does not apply for 2024.

• Variation: If the child’s investment income were $3,000, only the $400 excess would be subject to the Kiddie Tax, a relatively small burden.

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Choose the Right Investments

• Growth Stocks: Investing in growth stocks that pay little or no dividends minimizes unearned income, reducing Kiddie Tax exposure. Selling loss positions to offset gains can also help keep unearned income under the threshold. Holding growth stocks until the Kiddie Tax no longer applies may allow taxation at low or 0% rates.

• Tax-Efficient Mutual Funds: Similar to growth stocks, holding tax-efficient mutual funds with a long-term strategy can reduce Kiddie Tax exposure.

• Series EE U.S. Savings Bonds: Interest on EE bonds is deferred until redemption, so they are not subject to Kiddie Tax until cashed. If redeemed after the Kiddie Tax no longer applies, the interest is taxed at the child’s lower rate. Interest is exempt from state income tax.

• Section 529 Plans: Withdrawals used for qualified higher education expenses (or up to $10,000 for K-12 tuition) are tax-free. Since no tax is imposed, the Kiddie Tax is irrelevant. However, nonqualified withdrawals result in ordinary income tax plus a 10% penalty on the earnings portion.

• Life Insurance Products: Permanent life insurance with investment accounts (such as universal or whole life policies) can serve as a college funding tool. Cash value grows tax-deferred, can be accessed through tax-free loans, and is generally excluded from FAFSA financial aid calculations.

  
  

Generating Earned Income

If a child aged 18–23 earns more than half of their own support, the Kiddie Tax does not apply. Even if the earnings are saved rather than spent, sufficient earned income qualifies. In such cases, the child is no longer a dependent, qualifies for the full standard deduction ($14,600 in 2024), and avoids the Kiddie Tax.

• Example 7: Yolanda (age 20, full-time community college student) has $7,000 of unearned income in 2024. The Kiddie Tax applies: $4,400 ($7,000 – $2,600) is taxed at 37% = $1,628, plus $1,300 taxed at 10% = $130. Total = $1,758. Without the Kiddie Tax, her liability would have been $570.

• Variation: If Yolanda also earned $15,000 from part-time work or family employment, and her total support was $30,000 (with $22,000 from her own income), then she provides more than half her support. In this case, she is not a dependent, qualifies for the full $14,600 standard deduction, and is not subject to the Kiddie Tax. Taxable income would be $7,400 ($7,000 + $15,000 – $14,600), taxed at 10% = $740. With the American Opportunity Credit ($2,500), her tax could be reduced to $0 with potential refund.

Conclusion and Future Caution

To be subject to the Kiddie Tax, a dependent child must have substantial investment assets. If unearned income only slightly exceeds the threshold, the burden is modest. However, beyond that level, strategies described above should be considered to minimize or avoid the Kiddie Tax.

Caution: This relatively manageable Kiddie Tax regime may change in the future. If parents’ marginal tax rates increase, the Kiddie Tax rate will rise accordingly. Stay alert to future developments.