How Do Custodial Brokerage Account Taxes Work?
Custodial brokerage accounts have unique tax rules. This guide explains how investment earnings are taxed and the procedures for reporting them correctly.
A custodial brokerage account allows an adult to manage investments on behalf of a minor. These accounts, established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), let a custodian buy and sell securities like stocks and mutual funds. The custodian controls the assets until the child reaches the legal age of adulthood, at which point the funds, which are an irrevocable gift, are fully theirs. However, investment earnings are not tax-deferred, meaning income like dividends, interest, or capital gains is subject to taxation in the year it is earned.
The Kiddie Tax Rules for Unearned Income
The “Kiddie Tax” rules target a child’s unearned income, which includes all income not received as pay for work, such as taxable interest, dividends, and capital gains. The purpose of this tax is to prevent parents in higher tax brackets from shifting investment assets to their children to take advantage of a child’s lower tax rate. These rules apply to children under age 18, or those under 24 if they are full-time students who do not provide more than half of their own financial support.
The Kiddie Tax uses a tiered structure for the 2025 tax year. The first $1,350 of a child’s unearned income is tax-free, as it is sheltered by the child’s standard deduction. The next $1,350 is taxed at the child’s marginal tax rate. Any unearned income exceeding the $2,700 total of these tiers is then taxed at the parent’s highest marginal tax rate.
For example, if a child has $5,000 in unearned income in 2025, the first $1,350 is tax-free. The next $1,350 is taxed at the child’s rate. The remaining $2,300 ($5,000 – $2,700) is taxed at their parent’s rate, which could be significantly higher.
Gift Tax Considerations for Contributions
When an adult contributes money or securities to a custodial account, it is an irrevocable gift to the minor, and the tax implications fall on the donor. Federal law provides an annual gift tax exclusion, which for 2025 is $19,000 per individual recipient. This allows a person to contribute up to that amount to a minor’s account without any gift tax consequences.
Married couples can use “gift splitting” to combine their individual exclusions, allowing them to jointly give up to $38,000 to a single minor in 2025. This strategy requires filing a gift tax return (Form 709) to signify the election, but no tax is typically owed.
Should a contribution exceed the annual exclusion limit, the excess amount is applied against the donor’s lifetime gift tax exemption, which is $13.99 million for 2025. A gift tax return must be filed to report the excess gift, but tax is only due if an individual’s total lifetime gifts surpass this amount.
Tax Reporting and Filing Requirements
The custodian will receive several tax forms from the brokerage firm, including Form 1099-DIV for dividends, Form 1099-INT for interest, and Form 1099-B for proceeds from security sales. These documents provide the necessary figures for calculating the child’s total unearned income. There are two primary methods for reporting this income.
The default method is to file a separate tax return for the child. If the child’s unearned income is subject to the Kiddie Tax, this return must include Form 8615, “Tax for Certain Children Who Have Unearned Income.” This form is used to calculate the tax owed at the parent’s rate by incorporating the parent’s tax information.
As an alternative, parents may report the child’s income on their own tax return using Form 8814, “Parents’ Election To Report Child’s Interest and Dividends.” This option is available only if the child’s income consists solely of interest and dividends, their gross income is less than $13,500 for 2025, and no estimated tax payments were made in the child’s name. While this method simplifies filing, it can result in a higher tax liability because the income increases the parent’s adjusted gross income (AGI), potentially phasing out certain deductions and credits.
Tax Implications at the Age of Majority
When the beneficiary reaches the age of majority, typically 18 or 21 as determined by state law, the custodian’s role ends. The custodian is legally required to transfer full control of the account and all its assets to the beneficiary.
The transfer of control itself is not a taxable event. Because no assets are sold during this process, no capital gains are realized, and the new adult owner assumes control of the existing investments. From this point forward, the tax dynamics of the account change.
Once the beneficiary takes control, the Kiddie Tax rules no longer apply to the account’s earnings. All future income will be taxed at the new owner’s individual tax rate. The custodian must provide the beneficiary with detailed records of the cost basis for every security, which is the original value of an asset for tax purposes. This information is needed for the new owner to accurately calculate capital gains taxes when they sell investments.