The “Kiddie Tax” and How to Avoid It

The “Kiddie Tax” taxes a child’s net unearned income over a threshold amount at their parent’s higher tax rate. The Kiddie Tax applies to a child if:

• the child is (a) under age 19 at the close of the tax year, or (b) a full-time student aged 19-23;
• the child’s unearned income exceeds an inflation-adjusted threshold amount ($2,600 for 2024; $2,500 for 2023);
• the child doesn’t file a joint return; and
• the child has at least one living parent at the close of the tax year.

In short, the Kiddie Tax taxes a child’s net unearned income over $2,600 at the parents’ higher marginal tax rate instead of at the child’s rate. If the child’s tax rate is higher, their net unearned income is taxed at the higher rate.

Note: For children over 18, including those 19 to 23 who are full-time students, the Kiddie Tax doesn’t apply if the child’s earned income is more than one-half of the amount spent to support the child.

Unearned Income

Generally, unearned income includes taxable interest, dividends, capital gains (including capital gain distributions), rents, royalties, pension and annuity income, taxable scholarship and fellowship grants not reported on Form W-2, unemployment compensation, alimony, the taxable part of Social Security and pension payments, and income (other than earned income) received as the beneficiary of a trust.

Note: Unearned income doesn’t include any nontaxable unearned income, such as tax-exempt interest and the nontaxable part of social security and pension payments.

Avoiding the Kiddie Tax

To avoid paying the Kiddie Tax, parents should try to reduce or eliminate the child’s unearned income over $2,600 (for 2024). To do this, parents should consider investments that produce little or no taxable income, such as:

• securities and mutual funds oriented toward capital growth that produce little or no current income;
• vacant land expected to appreciate in value;
• stock in a closely held family business, that is expected to become more valuable as the family business expands, but pays little or no cash dividends;
• tax-exempt municipal bonds and bond funds; and
• U.S. Series EE bonds or I bonds for which recognition of income can be deferred until the bonds mature, the bonds are cashed in, or an election to recognize income annually is made.

Investments that produce no taxable income subject to the kiddie tax also include tax-advantaged savings vehicles such as:

• traditional and Roth individual retirement accounts (IRAs and Roth IRAs, which can be established or contributed to if the child has earned income;
• qualified tuition programs (QTPs, also known as 529 plans); and
• Coverdell education savings accounts (CESAs).

For more information about the Kiddie Tax and how you can avoid it by planning for your child’s future, contact us today.