Understanding the Implications of the Kiddie Tax on Your Child's Investments

The Kiddie Tax was introduced in the 1986 Tax Reform Act to prevent parents from shifting investment income to their children to avoid higher tax brackets. It taxes a child's unearned income—such as interest, dividends, and capital gains—at the parents’ tax rate once it exceeds a certain threshold. Originally limited to children under 14, the age limit was extended to 19 in 2013, including full-time college students without earned income. If a child's unearned income surpasses $2,000, it becomes taxable at the parents' rate, encouraging strategic investment planning for minors.

The goal of the Kiddie Tax is to promote transparency and prevent tax avoidance via minor accounts. Parents can report their child's investments on their tax returns or file separately. The first $1,000 of unearned income remains untaxed, while the next $1,000 is taxed at the child's rate. Income over $2,000 is taxed at the parent's rate, emphasizing the importance of careful investment management.

Parents should also consider that gifts or investments made in a child's name could impact college financial aid eligibility or scholarship opportunities. When children reach majority age, any funds in their name become their property, so planning is essential. With constantly changing tax laws, saving enough—around $250,000—is crucial for future educational expenses, given limited government support.