Parents and grandparents often want to give children a head start by investing money in their names. That instinct is a good one, but it comes with tax rules that are easy to overlook. The kiddie tax is a set of rules that can cause a child's investment income above a certain amount to be taxed at the parents' rates rather than the child's. It was designed to limit shifting investment income to children purely to save tax, and it can affect custodial accounts, inherited assets, and certain trusts. If you are thinking about how to save or invest for children, a complimentary, no-obligation wealth and tax review can help you see how the pieces fit.
This guide explains, in general terms, who the kiddie tax applies to, what types of income it covers, how it is reported, and how it shapes common strategies for saving for children.
What the Kiddie Tax Is
The kiddie tax applies to unearned income of certain children. Unearned income generally includes interest, dividends, capital gains, taxable distributions from trusts, and similar investment income. Under the rules, a small amount of a child's unearned income may be tax-free, the next portion is taxed at the child's own rate, and income above that is generally taxed at the parent's rate. The specific dollar amounts are adjusted periodically, so check current figures before planning.
Earned income, such as wages from a summer job, is generally not subject to the kiddie tax. It is taxed at the child's own rates.
Who It Applies To
The kiddie tax generally applies to children who are under a certain age at year end, as well as to older children who are full-time students under a higher age limit and whose earned income does not exceed a set portion of their support. The details depend on the child's age, student status, earned income, and whether at least one parent is alive. Because these rules involve specific thresholds that can change, confirm eligibility with a tax professional.
How It Is Reported
There are generally two ways the income may be reported:
On the child's own return. The child files a return and calculates the tax on unearned income using Form 8615, which looks to the parent's tax rate.
On the parent's return. In some cases, parents may elect to include a child's interest and dividends on their own return using Form 8814, if certain conditions are met.
The parental election can simplify filing, but it may increase the parents' adjusted gross income, which can affect other items on their return such as deductions, credits, or Medicare premiums. Comparing both approaches each year is often worthwhile.
Accounts That Commonly Trigger the Kiddie Tax
Custodial accounts. UTMA and UGMA accounts are owned by the child, so their income is the child's income.
Inherited accounts. A child who inherits an IRA or taxable investments may receive distributions or income subject to the rules.
Trust distributions. Taxable distributions from a trust to a child may count as unearned income.
Large gifts. Sizable gifts of appreciated stock can produce dividends and gains in the child's name.
In each case, the key question is how much investment income the account produces in a year, not just how much money is in it.
Planning Approaches Families Use
The kiddie tax does not mean families should avoid saving for children. It means the account type and investments matter. Common approaches include:
529 education savings plans. Earnings in a 529 plan are generally not taxed as long as withdrawals are used for qualified education expenses. Wisconsin residents may also qualify for a state subtraction for contributions to Edvest. See our guide to 529 plans and Edvest.
Roth IRAs for working children. A child with earned income may be able to contribute to a Roth IRA, which can grow tax-free under the rules.
Tax-efficient investments in custodial accounts. Investments that generate lower current income can reduce annual unearned income.
Timing of gains. Realizing gains in years when they fall within the lower tiers, or deferring them until the child is no longer subject to the kiddie tax, may help.
Keeping some savings in the parents' names. This preserves flexibility and control.
Each approach has tradeoffs around control, financial aid, and flexibility. Custodial assets become the child's property at the age of majority set by state law, and they can affect financial aid calculations differently than parent-owned assets.
How It Fits Into Family Wealth Planning
The kiddie tax is a small piece of a larger conversation about how families transfer wealth and prepare the next generation. Gifts to children interact with gift tax reporting, education goals, estate planning, and family values about money. Our article on generational wealth planning covers those broader questions.
Considerations for Grandparents and Other Relatives
Grandparents often want to help with education or a first investment account, and their gifts can raise the same kiddie tax questions as gifts from parents. A few points are worth considering before making a gift. First, consider where the money will be held. A gift to a 529 plan owned by a parent or grandparent may be simpler from a tax and financial aid standpoint than a gift to a custodial account. Second, consider what the gift will be invested in, since appreciated stock with a large built-in gain can produce taxable income for the child when sold. Third, consider gift tax reporting. Gifts above the annual exclusion amount generally require a gift tax return, even if no tax is due.
Families with several generations giving to the same children may benefit from a coordinated plan, so that gifts support shared goals and the reporting stays organized. Our estate planning checklist can help families think through those broader decisions.
Next Steps
Whether you are a parent in Madison opening a first custodial account or a grandparent in Waunakee planning gifts to several grandchildren, it helps to know how the kiddie tax may apply before money moves. A thoughtful structure can support your goals while keeping tax reporting manageable.
To talk through options for your family, request a complimentary, no-obligation wealth and tax review. Compound's tax planning and preparation team can coordinate the reporting with your broader plan.
Frequently Asked Questions
What is the kiddie tax?
The kiddie tax is a set of rules that can cause a child's unearned income above a certain amount to be taxed at the parent's rate instead of the child's.
Does the kiddie tax apply to a child's wages?
Generally no. Earned income, such as wages, is taxed at the child's own rates.
Do 529 plans trigger the kiddie tax?
Earnings inside a 529 plan are generally not taxed when used for qualified education expenses, so they typically do not create kiddie tax issues.
Can parents report a child's income on their own return?
In some cases, parents may elect to include a child's interest and dividends on their return, though this can raise the parents' income for other purposes.
How do custodial accounts affect financial aid?
Custodial accounts are the child's assets and may be treated differently than parent-owned assets in financial aid formulas. Review the impact before funding a large custodial account.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Investing involves risk, including possible loss of principal. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
Information may be generalized or subject to change. Please contact our team for the most current and accurate information.
About Compound Wealth
Compound Wealth believes many financial decisions benefit from being evaluated together rather than independently. The firm integrates tax planning, wealth management, accounting, and business advisory services to help clients navigate financial complexity through a coordinated planning approach tailored to their evolving needs.
