A child’s unearned income is taxed differently from their earned income. Unearned income includes things like interest, dividends, and capital gains. It’s taxed at the child’s own tax rate, which is typically lower than their parents’ tax rate. However, if the child’s unearned income is more than a certain amount, it may be taxed at the parents’ higher tax rate. This is known as the “kiddie tax.” The kiddie tax is designed to prevent parents from shifting their high-taxed income to their children, who have lower tax rates.
Understanding the Kiddie Tax
The kiddie tax is a set of tax rules that apply to the unearned income of children under the age of 19. Unearned income includes interest, dividends, capital gains, and other passive income. The kiddie tax is designed to prevent parents from shifting high-taxed income to their children to take advantage of lower tax rates.
The kiddie tax is calculated by adding the child’s unearned income to the parent’s taxable income. The child’s unearned income is then taxed at the parent’s marginal tax rate. This means that the child’s unearned income could be taxed at a higher rate than if the child had earned it themselves.
Avoiding the Kiddie Tax
There are a few ways to avoid the kiddie tax. One way is to have the child earn the income themselves. This means that the child must perform actual work or services to receive the income. Another way to avoid the kiddie tax is to have the child invest the money in a custodial account. Custodial accounts are owned by the child, but the parent or guardian has control over the account until the child reaches the age of majority. The income earned in a custodial account is taxed at the child’s marginal tax rate, which is typically lower than the parent’s marginal tax rate.
Understanding Thresholds
There are also thresholds for when the kiddie tax applies. For 2023, the threshold for the kiddie tax is $2,550. This means that children with unearned income below $2,550 are not subject to the kiddie tax.
| Age | Threshold |
|---|---|
| Under 19 | $2,550 |
Earned vs. Unearned Income
Earned income is any money that a child earns from working, such as wages, salaries, tips, and bonuses. Unearned income, on the other hand, is any money that a child earns without working, such as interest, dividends, and capital gains.
Taxation of Unearned Income
- Unearned income of children under the age of 18 is generally taxed at a lower rate than the child’s parents’ income.
- The “kiddie tax” applies to unearned income of children under the age of 18 that exceeds a certain amount ($2,300 in 2023).
- Under the kiddie tax, the child’s unearned income is taxed at the child’s parents’ marginal tax rate if the child’s unearned income is more than $2,300.
Taxation of Earned Income
- Earned income of children is taxed at the same rate as the child’s parents’ income.
- The earned income tax credit (EITC) is a tax credit that is available to low- and moderate-income working individuals and families.
- The EITC can reduce the amount of taxes that a child owes on their earned income.
| Age of Child | Amount of Unearned Income | Tax Rate |
|---|---|---|
| Under 18 | $0-$2,300 | Child’s marginal tax rate |
| Under 18 | $2,300-$14,950 | Parent’s marginal tax rate |
| Under 18 | Over $14,950 | 37% |
| 18 or older | Any amount | Child’s own marginal tax rate |
Taxation of Trust Distributions
Trust distributions to children are generally taxed in the same way as other unearned income. This means that the child’s tax rate will depend on the amount of income they have from all sources, including trust distributions, interest, dividends, and capital gains.
- Children under the age of 18 are taxed at their parents’ marginal tax rate on unearned income up to a certain amount.
- For children over the age of 18, unearned income is taxed at the child’s own marginal tax rate.
The following table shows the tax rates for unearned income for children of different ages:
| Age | Tax Rate |
|---|---|
| Under 18 | Parents’ marginal tax rate |
| 18-24 | 10% |
| 25 and older | Child’s own marginal tax rate |
In addition to the regular income tax, children may also be subject to the kiddie tax. The kiddie tax is a 10% surtax that is imposed on the unearned income of children under the age of 18 that is above a certain threshold.
- For 2023, the threshold for the kiddie tax is $2,500 for children under the age of 18.
- If a child’s unearned income exceeds this threshold, the child’s unearned income will be taxed at their parents’ marginal tax rate, plus the 10% kiddie tax.
Special Rules for Children with High Income
If your child has more than $1,100 of unearned income, special rules apply. The child's unearned income is taxed at the parent's rate on the amount of the unearned income that's more than $1,100, up to the child's taxable income. Any unearned income the child has that is more than the child's taxable income is taxed at the rate of 39.6%.
| Type of Unearned Income | Taxed at |
|---|---|
| Up to $1,100 | Child's rate |
| $1,101-$1,150 | Parent's rate minus the child tax credit |
| $1,150-$7,750 | Parents’ rate |
| Over $7,750 | 39.6% |
Alrighty folks, that about wraps up our dive into the world of child unearned income tax. Hope it cleared up any questions you had. It can be a bit of a head-scratcher, I know. If you’re still feeling a bit lost, don’t worry. This is just an article! You can always come back here and give it another read, or check out some other articles on our site for more info. Thanks for hanging out, and remember – tax stuff doesn’t have to be scary.