Kiddie Tax – Complete Guide for the Parents

Last week, my neighbor Sarah asked me an interesting question while we were catching up over coffee. Her 12-year-old daughter had just inherited some stocks from her grandmother, and Sarah was worried about the tax implications. That’s when I realized how many parents are in the dark about the Kiddie Tax – a quirky nickname for a serious tax regulation that catches many families off guard.

So, I decided why not give you guys a rundown about Kiddie Tax? This information could come in handy. Especially when we are just a couple of months shy from the the new tax season of 2025.

Before breaking down this complex topic into bite-sized pieces that won’t give you a headache, I’d suggest you to read this explicit disclaimer.

The information provided on this blog is for educational and informational purposes only and should not be construed as legal, tax, or financial advice. While I strive to present accurate and up-to-date information, tax laws and regulations can change frequently and may vary based on individual circumstances. Therefore, you should consult with a qualified tax professional or legal advisor before making any decisions or taking any actions based on the information provided here.

What’s This “Kiddie Tax” All About?

Back in 1986, when Top Gun was ruling the box office and everyone was wearing shoulder pads, Congress introduced the Kiddie Tax as part of their Tax Reform Act. Why? Well, they’d caught on to a clever trick some parents were using – shifting their investment income to their kids to pay lower taxes. Pretty smart, right? But the IRS wasn’t too thrilled about it.

Think of the Kiddie Tax as the IRS’s way of saying, “Nice try, but no dice!” If your child earns money from investments (we’re talking about things like stock dividends or interest from savings accounts), anything above certain limits gets taxed at your tax rate, not theirs.

Who Needs to Worry About Kiddie Tax?

You might need to pay attention if:

• Your child is under 18
• You’ve got a full-time student between 19 and 23 who still depends on you for more than half their support (in other words, they’re not paying their own bills yet)

The Kiddie Tax Rule — What Income Is Subject To The Kiddie Tax?

So, what exactly is this Kiddie Tax Rule?

Does the child have to pay the Kiddie Tax on each and every penny? If not then exactly what income is subject to the kiddie tax?

Well, when it comes to the kiddie tax, not all money is created equal in the eyes of this tax rule!

Let’s say your teenager has a summer job at the local ice cream shop. That hard-earned money — It’s safe from the Kiddie Tax. But the dividends from those “boring” stocks their grandparents gave them? That’s where Uncle Sam starts paying attention.

In short, the Kiddie tax applies only to the “Unearned Income” of your kid.

What is Considered Unearned Income for the Kiddie Tax?

In order to become liable to the Kiddie Tax, income should come from these sources:

• Interest from savings accounts (yes, even that measly 1% interest)
• Stock dividends (even if they’re reinvested)
• Capital gains (when those investments make a profit)
• Income from those custodial accounts you set up years ago
• Rent from property, such as a rental home or even a room
• Trust and state distributions
• Taxable Scholarships
• Royalties earned from intellectual property rights, such as book royalties, patents, or music rights.
• Gifts of stock or bonds received let’s say from parents or grandparents.

Kiddie Tax Rate & Threshold – 2024

The current threshold from IRS fror the unearned income liable to kiddie tax is $2,600.

What this means is that anything above $2,600, your child’s unearned income will be taxed at your/parents’ marginal tax rate.

Example

If the above sounds too technical then let me share a real-world example that might help.

Let’s say my friend Tom’s daughter Emma had $3,000 in dividend income last year from some stocks her grandfather left her. Here’s how it played out:

• First $1,300: This was completely tax-free thanks to the standard deduction. (Think of it as a freebie from the IRS.)
• Next $1,300: This got taxed at Emma’s rate, which was pretty low since she only had this investment income.
• Final $400: This is where the Kiddie Tax kicked in, and it was taxed at Tom’s higher tax rate. Or as we call “The parents’ Marginal Tax Rate”!

Who Is Supposed To Declare and File The Kiddie Tax?

Now comes everyone’s favorite part – filing taxes!

You’ve got two options here:

1. Your child can file their own return (if they’re feeling ambitious or you want to start teaching financial responsibility early)
2. You can add their income to your tax return using Form 8814 – Parent’s Election to Report Child’s Interest and Dividends (if you meet certain conditions and don’t mind doing the extra work)

But wait! Before you jump at the chance to simplify things by adding it to your return, make sure you qualify. You can only do this if:

• Your child hasn’t hit their 19th birthday (or 24th if they’re hitting the books full-time)
• Their income was under $12,500 (not exactly trust fund territory)
• They only had interest and dividend income (no crazy cryptocurrency gains!)
• They haven’t started playing the estimated tax payment game
• They’re not married and filing jointly with someone else

Is There Any Legal Way Out Of Kiddie Tax?

Now, don’t get me wrong. I’m not suggesting Tax Avoidance by any means. I always encourage others to pay their bills, taxes and dues on time. However, if there is any legally allowed way of reducing your tax bills then there’s no harm learning about them.

Right?

After years of helping friends navigate this, I’ve picked up some useful strategies:

1. Keep Your Eyes on the Prize: Monitor those investment accounts like a hawk. When they start generating serious income, it might be time for a chat with a financial advisor.
2. Think Twice About Custodial Accounts: They’re great for saving, but they can be a tax headache waiting to happen. Consider them carefully.
3. The 529 Plan Secret: Here’s a pro tip – 529 education savings plans aren’t subject to the Kiddie Tax. It’s like finding a secret passage in a maze!

Final Thoughts

The Kiddie Tax might seem like a pain, but it’s really just the government’s way of keeping things fair. Understanding how it works is like having a good map – it helps you navigate without getting lost or running into expensive surprises.

And remember, if you’re scratching your head over any of this (trust me, you’re not alone), there’s no shame in calling in a professional. A good tax advisor can save you more money than they cost, especially when dealing with these tricky situations.

After all, nobody wants to pay more taxes than they have to – we just need to play by the rules while we’re avoiding them!