A key to maximizing a family’s after-tax investment income is to navigate the Kiddie Tax. Don’t make gifts of investment property to children or grandchildren without knowing the rules.
The Kiddie Tax applies to unearned (investment) income of dependents under age 19 (or dependent full-time students under age 24).
The Kiddie Tax was enacted to limit a strategy called income splitting that reduced a family’s taxes on investment income. Investments were held in children’s names where the income would be taxed at much lower tax rates than when held in the parents’ names.
A common strategy was for a parent to buy stocks or mutual funds. After they appreciated, title was transferred to a child and the stocks were sold. Capital gains taxes would be very low or zero, because they were at the child’s tax rate.
To minimize the benefits of income splitting, the Kiddie Tax was introduced in the Tax Reform Act of 1986 and overhauled in the Tax Cuts and Jobs Act in 2017 and again in 2019’s Setting Every Community Up for Retirement Enhancement Act.
I won’t review the changes each of those laws made.
All you need to know is the SECURE Act repealed the TCJA changes and basically restored the pre-2018 framework.
The Kiddie Tax is imposed on most non-employment income of the child, including interest, dividends, capital gains, rent, and royalties.
In 2025, unearned income up to $1,350 is protected by the dependent child’s standard deduction. The next $1,350 of unearned income is taxed at the child’s tax rate, which probably is 0% unless the child has earned income. (These levels are indexed for inflation each year.)
All unearned income above $2,700 is taxed at the marginal tax rate of the child’s parent or guardian, when the Kiddie Tax applies.
When the Kiddie Tax is triggered, the normal filing process is for an income tax return to be prepared and filed for the youngster with Form 8615 attached. The form lists the child’s investment income and has details about the parent’s return.
Some parents aren’t comfortable with this approach when the child is old enough to want to see the tax return and sign it. The parents might not want to share that much detail about their finances with the child.
For those and other cases, there’s an option for the parents simply to include the investment income of the children on their own tax returns. The parents elect this option by filing Form 8615 with their Form 1040. This option is not available when the child’s unearned income is $13,000 or higher.
At recent interest rates and dividend yields, a youngster can have between $60,000 and $100,000 invested in his or her own name without triggering the Kiddie Tax, depending on how the money is invested. But a smaller portfolio will trigger the tax if it earns a higher yield or asset sales result in capital gains exceeding $2,700.
Only investment income that is otherwise taxable faces the Kiddie Tax. The tax can be avoided if, for example, the youngster owns mutual funds that don’t make significant distributions or stocks that don’t pay much in dividends, and the child doesn’t sell them.
Tax-exempt bonds and mutual funds also avoid the Kiddie Tax, regard less of how much income they generate.
On the other hand, events outside your control or expectations can trigger the tax. A mutual fund that’s had low distributions for years might have big gains or another event that causes a large distribution for the year, giving you little time to plan for it.
When more than one child in a family is subject to the Kiddie Tax, all the children’s investment income subject to the tax is added to the parent’s income to determine the tax rate.
An option to avoid the complications of the Kiddie Tax and give the parents more control is to have a trust hold investments that benefit the child.
Carefully consider all the implications. You need substantial assets to justify the cost of the trust.
Also, it takes careful distribution management to minimize family income taxes when children are young enough to trigger the Kiddie Tax.
When investment income is accumulated in the trust, the trust vaults into the top tax bracket in 2025 when its taxable income is only $15,650.
When income is distributed to the child, it retains the same character it had in the trust. So, if a trust distributes investment income, it is reported as investment income on the child’s tax return and could trigger the Kiddie Tax.
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