Minors Taxed at Special Rates: the Kiddie Tax

At one time, wealthy families could save a great deal of money by transferring investment assets to minor children. Tens of thousands of dollars in investment income produced by those assets would be taxed to the children at the lower rates that apply to individuals who have relatively little income. Congress decided to limit the tax benefit from shifting income to children, so we now have a law that says certain children that have more than a small amount of investment income have to pay tax at special rates.

“Kiddie tax.” The rule originally applied to children under 14 years of age, leading it to be called the kiddie tax. The name has stuck even though subsequent legislation extended it to certain students up to age 24.

Income threshold

You don’t have to worry about this rule until your child has investment income greater than a threshold amount, which is two times the amount allowed as a standard deduction for a dependent who has only investment income. For 2019, that amount is $1,100, so the kiddie tax begins to apply when your child has more than $2,200 in investment income.

Your child can still owe regular income tax with less than $2,200 in income. This is merely the threshold amount of investment income for the special kiddie tax.

Children affected by the rule

The application of the kiddie tax depends partly on your child’s age as of the end of the year. For this purpose a child born January 1 is treated as if he or she reached the age of that birthday on December 31 of the previous year. We now have different rules for four different age groups:

• Until the year your child turns 18, the kiddie tax applies automatically if your child has the amount of investment income described above.
• In the year your child turns 18, the kiddie tax applies unless your child’s earned income is more than half his or her overall support. Note that “earned income” for this purpose includes money your child earns by working but not investment income.
• For the year your child turns 19 through the year your child turns 23, the kiddie tax applies to a child who is a full-time student during any part of at least five months during the year unless the child’s earned income is more than half his or her overall support. In other words, your child has two ways to avoid the kiddie tax: earn enough income or stop being a full-time student.
• Beginning with the year your child turns 24, the kiddie tax doesn’t apply at all, even if your child is living off investments and plugging away at that PhD.

Note: The kiddie tax doesn’t apply if your child is married filing jointly.

How it works

If your child has more than $2,200 in investment income, the tax is figured according to a special calculation. The first $2,200 of investment income is still taxed at the child’s lower rates, but any additional investment income is taxed at the rates that apply to the taxable income of trusts and estates.

Example: In 2019 your child has $3,200 of interest income and no other income. The first $1,100 of investment income escapes taxation: your child’s standard deduction takes care of that. The next $1.100 is taxed at the child’s rate of 10%. That leaves $1,000 to be taxed at the rates that apply to trust income.

The income tax rates of trusts are highly compressed in comparison to individual income tax rates. For example, single taxpayers begin paying the maximum income tax rate of 37% when taxable income exceeds $510,300 (for 2019). Trusts begin paying this rate when taxable income exceeds $12,750. As a result, it will usually be disadvantageous to shift more than a small amount of investment income from parents to children who are subject to this rule.

The special rates on long-term capital gain and qualified dividends are also compressed. Single individuals who are not subject to the kiddie tax get a zero rate with income up to $39,375 (2019). In the kiddie tax, the maximum zero rate amount is $2,650.

Note: For tax years prior to 2018, individuals subject to the kiddie tax paid tax at their parents’ rates, not at the rates for trusts and estates. The 2017 tax law changed this rule for tax years 2018 through 2025. The new rule is simpler, but also potentially stricter.