The kiddie tax is a rule that requires that some investment income earned by minors be reported on the child’s own tax return at a rate equal to that of their parents' marginal tax rate.
The rule is intended to be a deterrent for parents who are considering moving ownership of income-producing assets into the names of their children who would be subject to a lower tax rate. Learn more about how the kiddie tax works and how it may affect your child.
Definition and Example of the Kiddie Tax
The kiddie tax is the tax liability on a child’s unearned income, or investment income. The tax is actually aimed at parents who might want to take advantage of their child’s lower tax bracket. It’s intended to discourage them from transferring ownership of their own income-producing assets to a child with a much lower tax bracket.
For example, you might own an asset that produces $50,000 in investment income annually. If you fell into the 37% marginal tax bracket, you would have to pay $18,500 or 37% of that money in tax to the IRS if you were to report it on your own tax return.
Now, if your child had no other income, their tax bracket for $50,000 may be 22%. Your child would therefore hypothetically pay only $11,000 in taxes (22% of $50,000) if you transferred ownership to them. Your family would save $7,500 of that investment income—the difference between the $18,500 you would owe and the $11,000 your child would owe.
In reality, the kiddie tax prevents such moves. It requires that the income be taxed at your bracket regardless of whether your child owns the assets.
The kiddie tax applies to unearned income, including capital gains, interest, and dividends earned in the child’s name, but not earned income such as wages they might earn.
The kiddie tax has undergone some changes over the years. It was first introduced by the Tax Reform Act of 1986. The Tax Cuts and Jobs Act (TCJA) hiked the applicable tax rate in 2018 and 2019, setting it at the rate paid by estates and trusts.
This change was repealed effective tax year 2020 so the kiddie tax rate has been returned to children’s parents’ highest tax rate.
How the Kiddie Tax Works
The kiddie tax applies to a minor’s unearned income over $2,200 as of tax year 2021 (rising to $2,300 for tax year 2022).
The child’s age factors in as well. The kiddie tax only applies if your child turns 18 on or before the last day of the tax year unless you personally did not have earned income that exceeded the amount you paid for your child’s support needs in that year. Another exception exists if the child is age 19 through 24 at the end of the tax year, but doesn’t have earned income for the year that amounts to more than what you paid for their support.
At least one parent must be living as of the last day of the tax year, the child must be required to file a tax return, and they can’t file a joint return with a spouse if they happen to be married. The child does not have to be claimed as your dependent on your taxes. They can be your biological child, adopted, or a stepchild.
Here’s how a child’s unearned income is taxed:
- The first $1,100: not taxed because of the standard $1,100 deduction
- The next $1,100 (of a total of $2,200): taxed at the child’s marginal tax rate
- Unearned income over $2,200: taxed at the parent’s marginal tax rate
The rules change and become much more complicated if your child also has earned income from a job. You might want to consult with a tax professional if this is the case.
Requirements for the Kiddie Tax
Your child must file a tax return if the kiddie tax applies to them, and they must additionally complete and submit IRS Form 8615 with the return.
You can report your child's unearned income on your own tax return under some circumstances. Your child cannot have any earned income in addition to the investment income, and their investment income can’t exceed a certain amount ($11,000 for 2021, $11.050 for 2022). File IRS Form 8814 to make this election.
Your child also must be younger than 19 at the end of the tax year if you want to report their unearned income on your tax form, and they can't have made any estimated tax payments or have carried over a refund from a previous year to apply to the current year. Their income was not subject to backup withholding.
How Much Is the Kiddie Tax?
The kiddie tax rate uses parents' marginal tax rate or the rate they pay on their top dollars of income, so any additional income would fall into this bracket until it reaches the next highest tax bracket. The top tax brackets are 32%, 35%, and 37% as of the 2021 (and 2022) tax year.
Your child’s unearned income might additionally be subject to the Net Investment Income Tax at a rate of 3.8% of their investment income, or 3.8% of the amount that their modified adjusted gross income exceeds a threshold set by their filing status.
Adjusting for the Tax Cuts and Jobs Act
The kiddie tax was even more formidable in tax years 2018 and 2019 before the Tax Cuts and Jobs Act’s provision for it was repealed.
You might be eligible for a refund if you or your child paid the kiddie tax at the TCJA rates in 2018 and/or 2019.
You can file an amended tax return, Form 1040X, in 2021 for one or both of those years if you paid the kiddie tax at the higher TCJA rates. Substitute your own marginal tax rate for the estate and trust tax rate. This could even potentially result in a tax refund.
- The kiddie tax rule requires that a minor’s unearned investment income must be taxed at their parents’ highest tax rate once it hits a certain level, rather than at their own rate.
- The kiddie tax was implemented to discourage parents from shifting ownership of income-producing assets to their children who would be taxed on it at a lower rate.
- Parents can elect to include their child’s unearned income on their own tax returns in some cases rather than have their child file their own tax return.