When children start earning money or receiving investment income, taxes may not be the first thing parents think about. However, if a child receives income from investments, such as interest, dividends, or capital gains, the kiddie tax may come into play.
What Is the Kiddie Tax?
The kiddie tax is a special U.S. federal tax rule designed to prevent families from transferring investment income to their children simply to take advantage of the child’s potentially lower tax rate.
While a child’s wages from a job are generally taxed using the child’s own tax rates, certain types of unearned income can be subject to special rules. Depending on the circumstances, some of that income may be taxed at the parent’s marginal tax rate.
Who Can Be Subject to the Kiddie Tax?
The rules generally apply to certain children under age 18 and, in some cases, full-time students under 24. The exact requirements depend on factors such as the child’s age, earned and unearned income, and whether the child provides more than half of their own financial support.
For example, a teenager who earns money from a summer job may have earned income, while a child who receives dividends from an investment account has unearned income. These two types of income can be treated differently for tax purposes.
What Types of Income Are Affected?
Unearned income can include:
- Interest from savings accounts or bonds
- Dividends from stocks or mutual funds
- Capital gains from investments
- Certain other investment-related income
Not every dollar of a child’s income is automatically subject to the kiddie tax. The rules determine how much, if any, unearned income receives special tax treatment.
Why Should Parents Pay Attention?
The kiddie tax can come as a surprise to families who have opened investment accounts for their children or who have transferred assets to them. A child may have relatively little income but still have a tax filing requirement because of investment earnings.
Keeping accurate records of interest, dividends, capital gains, and other income can make tax preparation easier and help prevent mistakes.
The Bottom Line
The kiddie tax is an important consideration for families whose children have investment income. Although the rules seem complicated, understanding the distinction between earned and unearned income is a good starting point. Because tax rules and income thresholds can change from year to year, parents should check the current IRS requirements or consult a qualified tax professional when determining whether the kiddie tax applies to their child.
All information is believed to be from reliable sources. However, we make no representation as to its completeness or accuracy. Cetera Wealth Services, LLC exclusively provides investment products and services through its representatives. Although Cetera does not provide tax or legal advice, or supervise tax, accounting or legal services, Cetera representatives may offer these services through their independent outside business. This information is not intended as tax or legal advice.
