What Is the Kiddie Tax and How Does It Work?

The Kiddie Tax, a provision within federal tax law, addresses situations where certain children have investment income. Its purpose is to prevent individuals from reducing their tax liability by transferring assets that generate income to children in lower tax brackets. This ensures investment income above a specific threshold is taxed at the parent’s marginal tax rate rather than the child’s potentially lower rate. This overview covers the Kiddie Tax rules applicable for the 2023 tax year.

Eligibility for the Kiddie Tax

The Kiddie Tax applies to a child who meets specific age and income criteria. A child is subject to these rules if they were under age 19 at the close of 2023, or if they were age 18 but their earned income did not exceed half of their total support. This also includes children aged 19 to 23 who were full-time students and whose earned income was not more than half of their total support.

In addition to these age and support requirements, the child must have had at least one living parent at the end of the tax year and must not be filing a joint tax return for 2023. The Kiddie Tax applies if the child’s unearned income surpassed a certain threshold, which for the 2023 tax year was $2,500. If parents are married but file separate tax returns, the income of the parent with the higher taxable income is used for the Kiddie Tax calculation.

Income Types Affected by the Kiddie Tax

The Kiddie Tax targets unearned income, which consists of investment income. This includes, but is not limited to, interest earned from savings accounts and bonds, dividends received from stocks and mutual funds, and capital gains realized from the sale of investments like stocks, mutual funds, or real estate. Income derived from rents, royalties, and distributions from trusts or estates also falls under the definition of unearned income.

Unearned income is distinct from earned income, such as wages, salaries, or tips from a job. Earned income is not subject to the Kiddie Tax rules and is taxed at the child’s own tax rate.

Determining the Kiddie Tax Amount

Calculating the Kiddie Tax focuses on the child’s net unearned income. For the 2023 tax year, the first $1,250 of a child’s unearned income is offset by the standard deduction allowed for dependents. The subsequent $1,250 of unearned income is then taxed at the child’s own income tax rate.

Any unearned income exceeding $2,500 is subject to the parent’s marginal income tax rate. For example, if a dependent child has $4,000 in unearned income and no earned income in 2023, the first $1,250 is covered by the standard deduction. The next $1,250 is taxed at the child’s rate, leaving $1,500 ($4,000 – $1,250 – $1,250) to be taxed at the parent’s rate. The parent’s applicable tax rate is determined by adding the child’s net unearned income to the parent’s own taxable income and calculating the tax as if it were all part of the parent’s income.

Reporting Kiddie Tax on Tax Returns

Reporting the Kiddie Tax involves specific IRS forms. Form 8615, “Tax for Certain Children Who Have Unearned Income,” is used to calculate the tax on the child’s unearned income at the parent’s rate. Form 8615 is attached to the child’s own tax return, Form 1040, when the child is required to file.

Alternatively, parents may elect to include their child’s income on their own tax return by using IRS Form 8814, “Parents’ Election To Report Child’s Interest and Dividends.” This option is available if the child was under age 19 (or under 24 if a full-time student) at the end of 2023, had only interest and dividend income (including capital gain distributions), and their gross income was less than $12,500.