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The term “kiddie tax” pertains to the taxation of a child’s net unearned income at the rate of the parent, rather than the child’s rate, while earned income remains subject to the child’s own rate.
The reason behind the kiddie tax is to prevent parents from reducing their tax obligations by transferring assets generating investment income (like dividends, interest, royalties, etc.) to a child subject to a lower tax rate.
This tax aims to discourage parents from gifting substantial stocks to their children in lower tax brackets to evade taxation, particularly given that taxes for estates and trusts are flat compared to individual tax rates. Such arrangements often lack substantial economic substance and primarily serve the purpose of tax avoidance.
The kiddie tax rules established by the Tax Cuts and Jobs Act of 2017 (TCJA) were altered by the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). Starting from tax years after December 31, 2019, a child’s net unearned income is no longer taxed based on estate and trust tax rates, but follows the pre-TCJA rules, as elaborated further in this article.
Additionally, taxpayers have the option to retroactively apply the SECURE Act rules to tax years 2018 and 2019. In case taxpayers wish to capitalize on this change, previously filed returns for 2018 and 2019 must be amended. Regardless of whether this amendment is made or not, the enhanced AMT exemption amount introduced by the SECURE Act remains applicable.
If opting for an amendment, a statement declaring the “election to modify tax on unearned income” must be included. Under this provision, the child subject to the kiddie tax utilizes the AMT standard deduction for single individuals. There exists no special AMT exemption for kiddie tax filers.
Under the kiddie tax rules, a child’s net unearned income (defined below) is subject to taxation at the parent’s highest marginal tax rate, provided the following conditions are met:
For the purposes of these regulations, “child” encompasses legally adopted children and stepchildren. These rules apply regardless of whether the child is a dependent.
Unearned income refers to any income not categorized as earned income under the foreign earned income exclusion. For this context, earned income comprises:
If the child engages in a trade or business where both personal services and capital play substantial roles in income generation, a reasonable allowance for the child’s personal services, not exceeding 30% of their share of the net profits from the business, is regarded as earned income. The 30% limit doesn’t apply in cases where the child’s business incurs a loss during the year. If capital is not a significant factor in income production, all income from the business is considered earned income.
Unearned income also incorporates amounts produced by assets a child acquired with earned income (e.g., interest on a savings account into which wages were deposited).
Note: Unearned income can also be nontaxable, encompassing tax-exempt interest and the nontaxable portion of social security and pension payments.
Net unearned income represents the surplus of a child’s unearned income over the sum of:
Net unearned income must not exceed the child’s taxable income for the year.
Form 8615, “Tax for Certain Children Who Have Unearned Income,” is used to determine the applicable tax on the child’s net unearned income.
Election to Report Child’s Interest and Dividend Income on Parent’s Return
When a child is subject to the kiddie tax rules, parents can choose to incorporate the child’s interest and dividend income into their own return instead of filing a separate return for the child. In such cases, the child is not required to file a return.
Important: If the child earns income beyond interest, dividends, capital gains distributions, and Alaska Permanent Fund Dividends—such as wages or capital gain from stock sales—none of the child’s income can be reported on the parents’ return.
If the child needs to file a return, Form 8949 (and Schedule D) are used to report capital gain income on the child’s individual return. If the child is subjected to the kiddie tax, Form 8615 is filed alongside the child’s return.
The Tax Cuts and Jobs Act of 2017 (TCJA) introduced adjustments to the kiddie tax for tax years starting after December 31, 2017, and applicable through 2025. During this period, a child’s unearned income was taxed according to estate and trust tax rates. For insights into the kiddie tax under TCJA, refer to “What are the kiddie tax rules under the Tax Cuts and Jobs Act of 2017?” The SECURE Act subsequently reversed these changes, permitting taxpayers to amend returns if the TCJA rules were used in 2018 or 2019.
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