DEFINITION of 'Kiddie Tax'

A special tax law created in 1986 imposed on individuals under 17 years old whose earned income is more than an annually determined threshold. Any extra income earned above of the threshold is taxed at the guardian's rate.

BREAKING DOWN 'Kiddie Tax'

This law is designed to prevent parents from exploiting a tax loophole where their children are given large "gifts" of stock. The child would then realize any gains from the investments and be taxed at a far lower rate compared to if the parents had realized the stock's gains.

Originally, the tax only covered children under 14 years of age as they cannot legally work and therefore any income was usually the results of dividends or interest from bonds. However, the tax authorities realized that some parents would take advantage of the situation by giving stock gifts to their older, 16-to-18-year-old children.

As of May 2007, the government is seeking to tighten the kiddie tax to cover individuals under the age of 18 (or under the age of 24 if they are full time students). However, there are some exceptions provided for individuals that work paid jobs.

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