Are Custodial Accounts Taxable? Tax & Filing Rules
Learn how custodial account earnings are taxed. This guide clarifies the tax liability for the minor, the influence of a parent's tax rate, and rules for contributors.
A custodial account is a financial account established for a minor, managed by an adult custodian. These accounts are governed by state laws, specifically the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). They provide a straightforward way for adults to give financial gifts to a child without the complexity of a formal trust.
From the moment a contribution is made, the assets are the irrevocable property of the minor. The custodian has a fiduciary duty to manage the account for the child’s benefit. Once the minor reaches the age of majority, between 18 and 25, the custodian must transfer full control of the account assets to the beneficiary.
Taxability of Custodial Account Earnings
While contributing to a custodial account is a gift, the earnings generated by the assets are subject to income tax. The account itself is not taxed, but any income it produces is considered unearned income belonging to the minor. This means the minor, not the custodian, is the legal taxpayer responsible for any tax liability, and the account is reported under the minor’s Social Security number.
Taxable income includes dividends paid by stocks, interest earned from bonds, and capital gains realized from the sale of appreciated assets. The financial institution where the account is held tracks these earnings and will issue tax forms, such as Form 1099-DIV or Form 1099-INT, in the minor’s name. These forms report the total unearned income needed for tax purposes.
Understanding the Kiddie Tax Rules
To prevent high-income parents from shifting investment income to their children for a lower tax rate, the IRS implemented the “Kiddie Tax.” These rules apply to a child’s unearned income above a certain threshold. The Kiddie Tax applies to children under age 19 and full-time students under age 24 whose earned income does not cover more than half of their own support. It ensures that significant investment income is taxed at the parents’ higher marginal tax rate.
The calculation of the tax is tiered. For the 2025 tax year, the first $1,350 of a child’s unearned income is tax-free, as it is offset by the child’s standard deduction. The next tier of unearned income is taxed at the child’s own income tax rate. For 2025, this applies to income between $1,350 and $2,700. This portion is taxed at the lowest marginal tax rates, often 10% or 12%.
Any unearned income exceeding $2,700 for 2025 is subject to the Kiddie Tax. This income is taxed at the parents’ highest marginal tax rate. For instance, if a child has $5,000 in unearned income, the first $1,350 is tax-free, the next $1,350 is taxed at the child’s rate, and the remaining $2,300 is taxed as if it were the parents’ income. This calculation is performed using Form 8615.
Gift Tax Considerations for Contributors
When an adult contributes money or assets to a custodial account, they are making a gift to the minor. Federal gift tax rules apply, but most contributions fall below the threshold that would trigger a tax liability. The IRS allows individuals to give up to a certain amount to any other person each year without gift tax consequences, which is known as the annual gift tax exclusion.
For 2025, the annual gift tax exclusion is $19,000 per recipient. A person can contribute up to $19,000 to a child’s account in a single year without needing to file a gift tax return (Form 709). Married couples can combine their annual exclusions through “gift splitting.” This allows them to jointly give up to $38,000 in 2025 to a single recipient tax-free.
Should a contribution exceed the annual exclusion amount, the excess is counted against the donor’s lifetime gift and estate tax exemption. This is a large, unified credit that covers taxable gifts made during a person’s lifetime and assets transferred upon their death.
Filing and Reporting Requirements
A federal income tax return is required for a dependent child if their unearned income exceeds their standard deduction amount. The return must be filed using Form 1040 under the child’s name and Social Security number.
If the child’s income is subject to the Kiddie Tax, Form 8615 must be completed and attached to their return. This form calculates the tax by applying the parents’ rate to the child’s excess unearned income. The parents’ tax information is needed to complete Form 8615 correctly.