What to Know About the Kiddie Tax
The Kiddie Tax is a tax law that can catch families off guard if they’re not aware of how it works. Designed to prevent parents from shifting investment income to their children to take advantage of lower tax rates, the Kiddie Tax applies to unearned income—such as interest, dividends, and capital gains—earned by children under certain conditions. What to Know About the Kiddie Tax is essential for families looking to avoid unexpected financial surprises.
At Molen & Associates, we help families navigate the complexities of tax laws like the Kiddie Tax to minimize their tax burden and ensure compliance. This guide explains what to know about the Kiddie Tax, how it works, and strategies to manage its impact on your family’s finances.
What is the Kiddie Tax?
The Kiddie Tax is a provision of U.S. tax law that taxes a child’s unearned income above a certain threshold at the parent’s tax rate. It applies to dependent children under specific circumstances and was created to discourage parents from transferring income-producing assets to children to take advantage of their lower tax brackets.
Who is Subject to the Kiddie Tax?
The Kiddie Tax applies to children who meet all of the following conditions:
- Age: The child is:
- Under 18 at the end of the tax year, or
- Under 24 at the end of the tax year if a full-time student and not providing more than half of their own support.
- Unearned Income: The child has more than $2,500 in unearned income in 2023 (this threshold is adjusted annually for inflation).
- Filing Status: The child must file a tax return because their income exceeds the filing threshold.
Unearned income includes:
- Interest from savings accounts or bonds.
- Dividends from stocks or mutual funds.
- Capital gains from the sale of assets.
- Certain types of distributions from trusts.
Earned income, such as wages or self-employment earnings, is not subject to the Kiddie Tax.
How Does the Kiddie Tax Work?
The Kiddie Tax is calculated as follows:
- The first $1,250 of unearned income is tax-free (in 2023).
- The next $1,250 of unearned income is taxed at the child’s tax rate.
- Any unearned income above $2,500 is taxed at the parent’s marginal tax rate.
For example, if your child earns $5,000 in unearned income and your highest tax bracket is 24%, the portion of their income above $2,500 will be taxed at your rate.
How to Report the Kiddie Tax
The Kiddie Tax is reported on the child’s individual tax return (Form 1040), using Form 8615 (Tax for Certain Children Who Have Unearned Income) to calculate the tax owed. Alternatively, parents can elect to include the child’s income on their own tax return under certain conditions using Form 8814 (Parents’ Election to Report Child’s Interest and Dividends).
Parents should weigh the pros and cons of each option carefully, as reporting a child’s income on their own return can sometimes result in higher taxes.
Strategies to Minimize the Kiddie Tax
1. Shift to Tax-Efficient Investments
Reduce the amount of unearned income subject to the Kiddie Tax by investing in assets that generate little or no taxable income, such as:
- Growth stocks (income is deferred until sold).
- Municipal bonds (interest is tax-exempt).
- Index funds with low dividend payouts.
2. Contribute to a 529 College Savings Plan
Funds in a 529 plan grow tax-free when used for qualified education expenses, avoiding the Kiddie Tax entirely.
3. Utilize the Standard Deduction
Encourage children to earn income through part-time jobs or small businesses. Earned income is eligible for the child’s standard deduction, reducing their taxable income.
4. Gift Strategically
Instead of transferring income-producing assets, consider gifting assets that generate minimal income or hold assets until the child is no longer subject to the Kiddie Tax.
5. Time Asset Sales Carefully
If possible, delay the sale of income-producing assets until the child is no longer subject to the Kiddie Tax rules.
Common Questions
Does the Kiddie Tax apply to college savings accounts?
The Kiddie Tax does not apply to funds in 529 college savings plans or Coverdell Education Savings Accounts, provided the funds are used for qualified educational expenses.
What if my child has both earned and unearned income?
Only unearned income is subject to the Kiddie Tax. Earned income is taxed at the child’s tax rate and qualifies for the standard deduction.
Can the Kiddie Tax apply to adult children?
Yes, the Kiddie Tax can apply to full-time students under age 24 if they are claimed as dependents and meet the income thresholds.
How can I avoid penalties or underpayment?
Work with a tax professional to estimate your child’s unearned income and adjust your withholding or make estimated tax payments if necessary.
How Molen & Associates Can Help
At Molen & Associates, we understand that navigating tax laws like the Kiddie Tax can be overwhelming. That’s why we’re here to help you with:
- Tax Planning: Develop strategies to minimize the Kiddie Tax’s impact on your family’s finances.
- Tax Preparation: Ensure accurate filing for both parents and children to avoid penalties.
- Education Savings Advice: Maximize the tax benefits of 529 plans and other savings vehicles.
With over 40 years of experience, we specialize in providing personalized guidance to families and small businesses, ensuring you feel confident and prepared.
Plan for a Tax-Smart Future
Understanding the Kiddie Tax can help you make better financial decisions for your family and avoid unexpected tax bills. Let Molen & Associates guide you through the process and ensure compliance while minimizing your tax burden.
Call us today at 281-440-6279 to schedule a consultation, or visit our website to learn more about our tax planning and preparation services. Together, we’ll create a tax strategy that works for your family.
