Understanding the Kiddie Tax

June 11, 2021
Does your child have unearned income? Make sure you understand Kiddie Tax rules.

Do your children have income-generating assets in a custodial account? If so, be sure you understand the so-called kiddie tax.

This law was passed to discourage wealthier individuals from transferring assets to their children to take advantage of their lower tax rates. The kiddie tax has seen many iterations (see “Refund, anyone?” below), but current rules tax a minor child’s unearned income—including capital gains distributions, dividends, and interest income—at the parents’ tax rate if it exceeds the annual limit ($2,200 in 2021).

The tax applies to dependent children under the age of 18 at the end of the tax year (or full-time students younger than 24) and works like this:

  • The first $1,100 of unearned income is covered by the kiddie tax’s standard deduction, so it isn’t taxed.
  • The next $1,100 is taxed at the child’s marginal tax rate.
  • Anything above $2,200 is taxed at the parents’ marginal tax rate.

If your child also has earned income, say from a summer job, the rules become more complicated. To learn more, see IRS Publication 929 or consult a tax advisor.

Refund, anyone?

If your family paid the kiddie tax in 2018 or 2019, you could be eligible for a refund.

The Tax Cuts and Jobs Act of 2017 effectively raised the kiddie tax by basing it on the tax rates used for estates and trusts, instead of the rates used for parents. That change has since been repealed, so if you calculated your child’s liability using estate and trust tax rates in 2018 or 2019, you have the option to file an amended return using your tax rate for your child’s unearned income instead. Just be sure the potential refund is worth the additional paperwork and any associated preparation costs.

If your family paid the kiddie tax in 2018 or 2019, you could be eligible for a refund.

The Tax Cuts and Jobs Act of 2017 effectively raised the kiddie tax by basing it on the tax rates used for estates and trusts, instead of the rates used for parents. That change has since been repealed, so if you calculated your child’s liability using estate and trust tax rates in 2018 or 2019, you have the option to file an amended return using your tax rate for your child’s unearned income instead. Just be sure the potential refund is worth the additional paperwork and any associated preparation costs.

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