What Is the Kiddie Tax?

by Bill Sweet

The "Kiddie Tax" (Tax on a Child's Investment and Other Unearned Income) is probably the most unfortunate name of a provision in the US tax code. It's designed to close a loophole that was pretty common pre-1986 of high-income earners shifting income onto their kids' tax bracket, realizing a reduction in tax.

It seems reasonable - a parent in a high tax bracket might say "hey, what if I give this to my kid, and he pays tax on it instead of me?" Since a child without any income won't generally pay any income tax, this seems like a great idea.

Of course there is a rule to prevent this: the dreaded KIDDIE TAX.

The rule kicks in for any dependent under the age of 19 (up to 24 if in college) who earns more than $2,100 in "unearned income" - generally interest, dividends, and capital gains.

Taxpayers who make roughly less than $10,150 of earned income typically don't have to file a federal tax return, but there is an exemption for unearned income. All taxpayers - regardless of age - must file a tax return if their unearned income exceeds $1,050 (if under 65). So if unearned income shows up on your kid's social security number on the IRS mainframe, you can't just ignore the income and not file.

The calculation of tax is a little goofy. There is a split - the first $1,050 of unearned income is offset by the standard deduction, therefore untaxed. The next $1,050 is subject to the child's tax rate (usually 10%). Any income higher than those amounts ($2,100 in total) are taxed at the parent's tax rate, which is usually higher.

Form 8615 needs to be filled out on the dependent's tax return to calculate the proper amount of income tax due.

A few examples follow. Let's use a married couple with $500,000 of gross income in 2015. They have two dependents. Total income tax on the income alone: $138,283 (27.6% effective,

If this hypothetical couple had an additional $10,000 of interest or dividend income of $10,000, they would pay an additional tax of $3,198 (28% + 3.9% investment income tax).

If they could shift the income to one of their dependents, in a world without the Kiddie Tax, the child would only pay income tax of $898 on the $10,000 of income (8.9%) for a tax "savings" of $2,300.

Of course we live in a world with a Kiddie Tax, so the actual tax calculated is $3,178 - nearly exactly the same as if the parent had claimed the income. But as long as the tax return was free, at least you saved twenty bucks.

- Bill