The Kiddie Tax: What Parents Need to Know Before Giving Investments to Children

Gifting investments to your children seems like a smart financial move—teach them about investing while building wealth for their future. But before you transfer that appreciated stock or add to their investment account, there's a tax rule you need to understand: the kiddie tax.

 

This rule has tripped up countless well-meaning parents and grandparents who thought they could shift investment income to their children's lower tax brackets. The IRS anticipated this strategy decades ago and created rules to ensure children's investment income doesn't escape taxation at higher rates. Understanding how the kiddie tax works can save you from an unwelcome surprise at tax time and help you make smarter decisions about building wealth for your children.

 

What Is the Kiddie Tax?

The kiddie tax isn't actually a separate tax—it's a set of rules that determine how a child's unearned income gets taxed. When your child has investment income above certain thresholds, that income gets taxed at your marginal tax rate instead of theirs.

 

The rule was introduced in 1986 to close a loophole where wealthy parents could transfer income-producing assets to their children and have that income taxed at the child's much lower rate. Without this rule, a parent in the 37% bracket could shift dividend income to their child who might pay 10% or even 0% on the same income.

 

For 2025, the kiddie tax works in three tiers. The first $1,350 of a child's unearned income is completely tax-free, covered by their standard deduction. The next $1,350 is taxed at the child's own marginal rate, which is typically 10% for most children. Any unearned income above $2,700 gets taxed at the parent's marginal rate—and that's where the real tax impact hits.

 

What Counts as Unearned Income?

The kiddie tax applies only to unearned income, which includes interest from savings accounts, dividends from stocks and mutual funds, capital gains from selling investments, rental income, royalties, taxable portions of scholarships (beyond tuition and required fees), and distributions from trusts.

 

What doesn't count? Earned income from jobs is taxed under regular rules, not the kiddie tax. So if your teenager earns money mowing lawns, babysitting, or working a summer job, that income is taxed at their own rate regardless of how much they make.

 

This distinction matters. A child could earn $15,000 from a part-time job and pay relatively little tax, while $5,000 in dividends from grandma's stock gift could trigger tax at their parents' 15% or 20% qualified dividend rate.

 

Which Children Are Subject to the Kiddie Tax?

The kiddie tax applies more broadly than many parents realize. It affects children under age 18 at the end of the tax year, children who are 18 at year-end and don't have earned income exceeding half their own support, and full-time students ages 19 through 23 who don't have earned income exceeding half their own support.

 

The support test is crucial. If your 20-year-old college student has a summer job that covers more than half their living expenses for the year, the kiddie tax doesn't apply to them. But if you're paying most of their bills while they focus on school, their investment income could still be taxed at your rate.

 

The rule requires at least one parent to be alive at year-end and that the child not file a joint return with a spouse. For divorced or separated parents, the income is taxed at the rate of the parent with whom the child lived most of the year.

 

A Real-World Example

Let's say you gave your 15-year-old daughter shares of stock five years ago. Those shares now generate $5,000 per year in qualified dividends. She has no other income, and you and your spouse file jointly with taxable income of $550,000, putting you in the 20% qualified dividend rate (the top capital gains bracket).

 

Under the 2025 kiddie tax rules, here's what happens. The first $1,350 is tax-free. The next $1,350 is taxed at her qualified dividend rate, which would be 0% given her low income level—so no tax on this portion. The remaining $2,300 is taxed at your 20% qualified dividend rate, resulting in $460 of tax. Her total tax bill on $5,000 of qualified dividends is $460.

 

Without the kiddie tax, she would have paid nothing—qualified dividends are taxed at 0% for taxpayers in the lowest brackets. Instead, most of her investment income is taxed at your rate, costing an extra $460.

 

How to Report the Kiddie Tax

You have two options for reporting a child's investment income subject to the kiddie tax.

 

The first option is filing a separate return for the child using Form 8615. This form calculates the kiddie tax by comparing what the child would owe at their own rate versus what they'd owe at the parent's rate. The child files their own Form 1040 with Form 8615 attached.

 

The second option is including the child's income on your return using Form 8814. This election is available only when the child's income consists solely of interest and dividends totaling less than $13,500. While Form 8814 simplifies the filing process, it often results in slightly higher taxes and increases your adjusted gross income, which can affect your eligibility for various tax benefits.

 

When You Have Multiple Children with Investment Income

Here's a complication that surprises many families: when more than one child is subject to the kiddie tax, the IRS doesn't calculate each child's tax in isolation. Instead, Form 8615 combines the net unearned income of all children in the family to determine the tax rate, then allocates the total tax back to each child based on their share.

 

Why does this matter? Because one child's investment income can push a sibling into a higher tax bracket. If you have three children each with $5,000 in unearned income, the combined $15,000 (less the threshold amounts) gets stacked on top of your income to determine the rate. The third child's income is taxed at a higher marginal rate than if they were an only child.

 

This also creates a practical headache: you can't finalize one child's return until you know all the siblings' investment income for the year. Each child's Form 8615 requires information about the other children's net unearned income to calculate the allocation correctly.

 

Strategies to Minimize the Kiddie Tax Impact

Understanding these rules opens up several planning opportunities.

 

The most straightforward approach is keeping investment income below the threshold. For 2025, if you keep your child's unearned income at or below $2,700, only a small portion gets taxed at their rate, and nothing triggers your higher rate. This might mean choosing growth-oriented investments that don't generate current income, or simply limiting how much you transfer to your child.

 

Tax-deferred accounts offer significant advantages. Investment earnings in 529 college savings plans and custodial Roth IRAs (for children with earned income) aren't subject to the kiddie tax because they don't generate current taxable income. The money grows without triggering annual tax consequences, making these accounts far more tax-efficient than regular investment accounts when building wealth for children.

 

Tax-advantaged investments can also help. Municipal bond interest is exempt from federal taxes, meaning it doesn't count as taxable unearned income for kiddie tax purposes. Similarly, focusing on growth stocks rather than dividend-paying stocks defers the tax impact until shares are sold—ideally after your child is no longer subject to the kiddie tax.

 

Common Mistakes to Avoid

Don't assume the kiddie tax only applies to young children. Full-time college students through age 23 can still be subject to these rules if they don't earn more than half their own support. Many parents are surprised when their 22-year-old's investment account triggers tax at the parents' rate.

 

Don't forget about capital gains distributions from mutual funds. Even if you never sell shares, mutual funds distribute capital gains annually, and these count as unearned income for kiddie tax purposes. An account holding actively managed funds could generate unexpected kiddie tax liability.

 

Don't overlook state taxes. Many states have their own version of the kiddie tax, and the rules may differ from federal. California, for example, has similar kiddie tax provisions. Make sure you understand your state's treatment.

 

Planning Ahead Makes All the Difference

The kiddie tax isn't a reason to avoid investing for your children—it's simply a factor to consider in how you structure those investments. With proper planning, you can still build substantial wealth for your children while minimizing unnecessary tax consequences.

 

Tax-deferred accounts like 529 plans and custodial Roth IRAs often make more sense than regular investment accounts, especially for families in higher tax brackets. When you do gift investments directly to children, being mindful of the types of investments and the amount of current income they generate helps keep the kiddie tax impact manageable.

 

Let Desert Rose Tax & Accounting Help You Plan

Investment decisions for your children involve both financial planning and tax strategy. At Desert Rose Tax & Accounting, we help families navigate the kiddie tax rules and structure children's investments tax-efficiently. Whether you're just starting to invest for your children or managing existing accounts, we'll ensure you understand the tax implications before they become tax surprises.

 

We can help you calculate the kiddie tax impact on your child's current investments, evaluate the most tax-efficient ways to build wealth for your children, structure investment gifts to minimize unnecessary taxes, and coordinate children's investment income with your overall tax planning.

 

Visit www.desertrosetax.com to schedule a consultation, or call us at (520) 747-4964. Let's make sure your efforts to build wealth for your children work as efficiently as possible.

 

Edward Ethington, CPA, CFP®, MBA
Desert Rose Tax & Accounting
Your Partner in Family Tax Planning
(520) 747-4964
www.desertrosetax.com

 

This blog provides general information about the kiddie tax and should not be construed as personal tax advice. Tax laws are complex and change frequently. Please consult with a qualified tax professional at Desert Rose Tax & Accounting for guidance specific to your family's situation.