What Is the Kiddie Tax?
- The kiddie tax prevents parents from avoiding taxes by transferring large gifts of stock.
- All unearned income over the threshold is taxed at the parent’s marginal income tax rate rather than the lower child’s tax rate.
- It applies to all children who are under 19 years of age—or dependent full-time students under 23.
- The kiddie tax applies to most unearned income that a child receives and does not apply to any salary or wages.
How the Kiddie Tax Works
The kiddie tax is a tax imposed on individuals under a certain age whose investment and unearned income is higher than an annually determined threshold.
This rule is designed to prevent parents from exploiting a tax loophole where their children are given large gifts of stock. In this case, the child would then realize any gains from the investments and would be taxed at a far lower rate compared to the rate the guardians face for their realized stock gains.
Under the kiddie tax law, all unearned income over the threshold is taxed at the parent’s marginal income tax rate rather than the child’s tax rate. In 2020, unearned income under $1,100 qualifies for the standard deduction, the next $1,100 is taxed at the child’s tax rate, which is very low, sometimes zero percent, and then anything in excess of $2,200 is taxed at the guardian’s tax rate, which could be as high as 37%.
Who and What the Kiddie Tax Applies To
As of 2020, the kiddie tax applies to all children aged 19 and under, as well as children who are dependent full-time students between the ages of 19 and 23. It does not apply, however, to children under these ages who are married and file joint tax returns.
The kiddie tax includes unearned income a child receives: gifts, inheritances, cash, stocks, bonds, mutual funds, and real estate. Wages from part- or full-time employment does not fall under the kiddie tax laws and are taxed at the regular child tax rate.
Children who turn 20—or 24 in the case of dependent full-time students—by the end of the tax year, are not subject to the kiddie tax.
History of the Kiddie Tax
The tax law originally only covered children under 14 years of age. Children under the age of 14 cannot legally work, which means that any income they received usually came from dividends or interest from bonds. However, the tax authorities realized that some guardians would take advantage of the situation, and then give stock gifts to their older, 16-to-18-year-old children.
The Tax Cuts and Jobs Act of 2017 (TJCA) greatly changed the kiddie tax. Under the TJCA, when a child’s income exceeded the threshold, the kiddie tax used a taxation structure where the amount earned dictated the tax rate based on the rates used for trusts and estates, which for many taxpayers was higher than the marginal income tax rate of the child's parents.
This rule was scrapped in 2020 with the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act reverted the tax rate for the kiddie tax to the parent's marginal rate. This change is also retroactive to the 2018 and 2019 tax years for those who choose to file an amended claim.