The Kiddie Tax: A Comprehensive Overview
The Kiddie Tax is a specific tax law applied to unearned income earned by individuals aged 18 or under—or dependent full-time students under age 24. This tax was introduced to prevent parents from evading taxes by placing investments under their children’s names. As of 2023, for unearned income surpassing $1,250, children are taxed at their own rate up to $2,500. Income exceeding this amount is taxed at the parent’s rate, which can be as high as 37%.
Key Takeaways
- The Kiddie Tax prevents tax avoidance by imposing taxes on large gifts of income-producing assets made to children.
- Earned income above the specified threshold is taxed at the parent’s marginal tax rate instead of the child’s typically lower tax rate.
- It affects all children under 19, or full-time students under 24, relying on their parents or guardians.
- Most unearned income sources, including dividends, interest, capital gains, rent, and royalties, are subject to this tax, while wages and salaries are exempt.
- For 2023, unearned income beneath $1,250 qualifies for the standard deduction.
How the Kiddie Tax Works
The Kiddie Tax targets unearned income of children. It applies to individuals aged 18 or less and dependent full-time students aged 19-24. The tax aims to close a loophole where parents gift substantial income-yielding stocks to children, who then realize the gains at a lower tax rate. For 2023, unearned income is taxed as follows:
- Income below $1,250 qualifies for the standard deduction.
- The subsequent $1,250 is taxed at the child’s rate.
- Income over $2,500 is taxed at the parent’s higher marginal rate.
Reporting the Kiddie Tax
Unearned income can be reported through two primary methods:
- The parent includes the child’s investment income within their tax filing using Form 8814.
- The child files IRS Form 8615 alongside their tax return, Form 1040, detailing the unearned income.
History of the Kiddie Tax
Initially covering children under 14, the Kiddie Tax was recalibrated to tackle misuse by parents gifting stocks to older offspring. The tax regime was adjusted by the 2017 Tax Cuts and Jobs Act but reverted in 2020 to taxing unearned income at the parent’s rate.
Who Is Subject to Kiddie Tax?
Any individual under 18 or full-time dependent students under 24 with unearned income over the annual threshold is subject to the Kiddie Tax.
Purpose of the Kiddie Tax
The Kiddie Tax was introduced to curb tax evasion tactics where parents would attribute taxable investments to their children to benefit from a lower tax bracket, thus reducing the overall tax burden.
Kiddie Tax Rate for 2023
For 2023, unearned income under $1,250 qualifies for the standard deduction. The succeeding $1,250 is taxed at the child’s marginal rate, and income over $2,500 is taxed up to the guardian’s rate of 37%.
Avoiding Kiddie Tax
Parents and guardians can avoid the Kiddie Tax by limiting the child’s annual investment income to $2,500. Strategies include choosing low-dividend investments or investing in bonds deferring interest payouts until the child is older.
The Bottom Line
Awareness of the Kiddie Tax and its limitations is crucial for parents managing investments for their children. Financial advisors or tax professionals can offer guidance to minimize the tax ramifications effectively.
Related Terms: unearned income, tax rate, standard deduction, financial planning, investment income.
References
- Internal Revenue Service. “Rev. Proc. 2022-38”.
- Internal Revenue Service. “Topic No. 553 Tax on a Child’s Investment and Other Unearned Income (Kiddie Tax)”.
- United States Senate Committee on Finance. “The Real Effect of the ‘Kiddie Tax’ Change”.
- U.S. Congress. “H.R.1 - An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018”.
- U.S. Congress. “H.R.1865 - Further Consolidated Appropriations Act, 2020”.
