Kiddie tax

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Kiddie tax is a tax imposed on a child's "certain unearned income" at the parent's marginal rate.

The term is found in the title of "IRS Topic No. 553 Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)", but not in any other IRS publication.

Background: "In 1986, Congress enacted the 'kiddie tax' as a response to parental abuse of tax rates. Some parents were transferring large amounts of unearned income, such as dividend and capital gains proceeds, to their children’s accounts to ensure taxation at the children’s lower tax rates." Since then, the law has been modified multiple times.

The kiddie tax in general
There are two rules that may affect the tax and reporting of the investment income of certain children: The following characterizes the kiddie tax: Note that by gifting appreciated securities to a child, one can avoid at most $345 ($2,300 &times; 0.15) in 2022 (if in the 15% Long Term Capital Gains (LTCG) bracket), or $547 ($2,300 &times; 0.238) (if in the 20% LTCG + 3.8% Net Investment Income Tax (NIIT) brackets).
 * 1) If the child's interest, dividends and other unearned income total more than $2,200 in 2021, $2,300 in 2022 (twice the basic standard deduction for a dependent minor of $1,100 or $1,150, indexed for inflation ), it may be subject to a specific tax on the unearned income of certain children.
 * 2) If the child's interest and dividend income (including capital gain distributions) total less than $11,500 (10 times the basic standard deduction of $1,150), the child's parent may be able to elect to include that income on the parent's return rather than file a return for the child. This may result in paying more tax than having the child file a tax return. (See Form 8814 and Publication 929.)
 * Applies if the child is < 24 and a full time student (lower ages if not), and has > $2,200 in unearned income for 2021, $2,300 for 2022
 * Anything over $2,300 in unearned income is taxed at the tax rate for the parents
 * Kiddie tax is calculated on Form 8615 and paid on child's return
 * The standard deduction for a child who can be claimed as a dependent is the greater of
 * $1,100 for 2021, $1,150 for 2022 (indexed for inflation)
 * earned income plus $350 for 2021, $400 for 2022 (indexed for inflation) but not more than the regular standard deduction amount, generally $12,550 for 2021, $12,950 for 2022 (indexed for inflation)

Taxation of children with no earned income
If the children have no earned income then:
 * The child (if a dependent) gets a Standard Deduction of $1,150
 * This has the effect of:
 * The first $1,150 of unearned income is untaxed
 * The next $1,150 is taxed at the child's rate
 * 0% for qualified dividend (QDI) and long term capital gain (LTCG)
 * 10% for Interest and non-QDI
 * Anything beyond that is taxed at the parents' tax rate

Examples
Example 1: Your child has no other income than $1,000 of LTCG from stock you gave him. His standard deduction is $1,150 and his taxable income is zero. You save $150 (15% of $1,000) in the 15% LTCG bracket compared to selling it yourself.

Example 2: Your child has no other income than $3,000 of LTCG from stock you gave her. Her standard deduction is $1,150 and her taxable income is $1,850. In 2022, since her unearned income is over $2,300, the last $700 is taxed at the parents' rate; if the parents pay 15% tax on LTCG, the tax is $105.

Example 3: (2022 optimal tax gain harvesting) Your child has no other income than $2,300 of LTCG from stock you gave her. Her standard deduction is $1,150 and her taxable income is $1,150. In 2022, since her unearned income is exactly $2,300, she has $0 taxed at the parents' rate.

Taxation of children with earned income
If the children have earned income then:
 * The standard deduction is $1,150 for 2021, $2,300 or (earned income + $400) for 2022, whichever is larger, but not more than the normal standard deduction of $12,550 for 2021, $12,950 for 2022 (indexed for inflation) for a single person.

Examples
Example 1: A child has $200 of earned income. His standard deduction is $1,150. With $500 of ordinary unearned income (interest, short-term capital gains (STCG), and non-QDI) and $1,300 of tax advantaged unearned income (QDI and LTCG), his total income is $2,000, and his taxable income is $850. Under the "income stacking rules" of the Qualified Dividends and Capital Gain Tax worksheet, all of his taxable income is tax advantaged, and his tax is $0.

Example 2: A child has $1,200 of earned income. Her standard deduction is $1,600 ($1,200 + $400). With $500 of ordinary unearned income (interest, STCG, and non-QDI) and $1,300 of tax advantaged unearned income (QDI and LTCG) her total income is $3,000, and her taxable income is $1,400. Under the "income stacking rules" of the Qualified Dividends and Capital Gain Tax worksheet, the taxable income consists of $150 of ordinary income ($500 - $400) and $1,300 of tax advantaged income. Her tax will be $10 (10% of $150).

Form 8514 - parents' election to report child's interest and dividends
"You may be able to elect to include your child's interest and dividend income (including capital gain distributions) on your tax return. If you do, your child won't have to file a return."

Figure 1 shows the conditions which allow you to attach Form 8814 to your tax return.

Form 8615 - tax for certain children who have unearned income
"If your child's interest, dividends, and other unearned income total more than $2,200, and you don't or can't use Form 8814 to include your child's income on your return, your child will use Form 8615 to figure their tax. Attach the completed Form 8615 to your child's Form 1040 or 1040-NR."

Figure 2 shows the conditions which allow you to attach Form 8615.

State kiddie tax
Some states have similar rules for taxing the unearned income of children; California is one of them.