What Is a Kiddie Tax?

Kiddie tax is a term that refers to a special tax law created in 1986 dealing with investment and unearned income tax for individuals under 17 years of age.

How a Kiddie Tax Works

The kiddie tax is a tax imposed on individuals under 17 years old whose investment and unearned income is higher than an annually determined threshold. Before 2018, The IRS taxed any income exceeding the predetermined threshold at the rate of the child’s guardian. The Tax Cuts and Jobs Act of 2017 greatly changed the kiddie tax. Now when a child’s income exceeded the threshold, the kiddie tax uses a taxation structure where the amount earned dictates the tax rate rather than the tax rate of the child's parents.

The kiddie tax 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 stocks’ gains.

Key Takeaways

  • The kiddie tax prevents parents from avoiding taxes by transferring large gifts of stock.
  • The kiddie tax applies to all children who are 19 years of age and younger.
  • This tax applies to most unearned income that a child receives and does not apply to any salary or wages.

Who and What the Kiddie Tax Applies To

As of 2018, the kiddie tax applies to all children 19 and under, and children who are dependent full-time students between the ages of 19 and 23. The kiddie tax includes unearned income a child receives: gifts, inheritances, cash, stocks, bonds, mutual funds, and real estate. Any salary or wages the child earns is not subject to the tax.

History of the Kiddie Tax Law

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 the child 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. In 2017, the tax threshold was set at $1,050, which meant there were no taxes on the first $1,050. After that, the IRS taxed the second $1,050 at the child’s tax rate, which is very low, sometimes zero percent. Any income exceeding $2,100 was taxed at the guardian’s tax rate, which could be as high as 39.6 percent.

Starting in 2018, the Tax Cuts and Jobs Act simplified the kiddie tax, though it will continue in its current iteration until 2025. In the new form, the kiddie tax stays the same for the first $2,100 of unearned income, but the IRS will tax the amounts over the $2,100 at the rates associated with different income brackets, as opposed to their parents’ tax rate. The rates range, with anything up to $2,500 taxed at 10 percent, $2,551 to $9,150 at 24 percent, $9,151 to $12,500 at 35 percent and anything over $12,501 at 37 percent.