Kiddie tax

The  rule can be found in the US tax code which "taxes certain unearned income of a child at the parent’s marginal rate, no matter whether the child can be claimed as a dependent on the parent’s return." The updates are in section A(1)(11001)(a)(4) of the 2018 tax law.

The kiddie tax in general
There are two rules may affect the tax and reporting of the investment income of certain children:
 * If the child's interest, dividends and other unearned income total more than $2,100 (twice the basic standard deduction for a dependent minor of $1,050 in 2017, indexed for inflation ), part of that income may be subject to tax at the parent's tax rate instead of the child's tax rate (in 2017) or the tax rate for trusts (in 2018 and later).
 * If the child's interest and dividend income (including capital gain distributions) total less than $10,500 (10 times the basic standard deduction of $1,050), 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, but this may result in paying more tax than having the child file a tax return (See Form 8814 and Publication 929). It is not clear whether this rule continues to 2018.)

The following characterizes the kiddie tax:


 * Very complex
 * Applies if the child is < 24 and a full time student (lower ages if not), and has > $2,100 in unearned income (limit for 2017 and 2018))
 * Anything over $2,100 in unearned income is taxed at the parent's rate (for 2017) or the tax rate for trusts (for 2018 and later)
 * 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
 * $1,050 (2017, indexed for inflation)
 * earned income plus $350 (2017, indexed for inflation) but not more than the regular standard deduction amount, generally $6,350 (2017, indexed for inflation)
 * Note that by gifting appreciated securities to a child, one can save at most $315 per year per child in capital gains tax in 2017 and $698 in 2018 (if in the 15% Long Term Capital Gains (LTCG) bracket) and up to $832 per year per child in 2017 (if in the 39.6% bracket with tax loss carryover, see note below) and $1193 in 2018 (if the parent pays 12% tax on capital gains, possibly with even more benefit from carryovers)

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 $1,050
 * This has the effect of:
 * The first $1050 of unearned income is untaxed
 * The next $1050 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' rate (in 2017) or at the rate for trusts (in 2018)

Taxation of children with earned income
If the children have earned income then:


 * The standard deduction is $1,050 or earned income + $350, whichever is larger, but not more than the normal standard deduction of $6,350 (2017, indexed for inflation) for a single person

Examples:

Example 1: A child has $200 of earned income. His standard deduction is $1,050. 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 $950. 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 $1,550. 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 $1,450. Under the "income stacking rules" of the Qualified Dividends and Capital Gain Tax worksheet, the taxable income consists of $150 of ordinary income ($500 - $350) and $1,300 of tax advantaged income. Her tax will be $15 (10% of $150).

Example 3: Your child has no other income than $3,000 of LTCG from stock you gave her. Her standard deduction is $1,050 and her taxable income is $1,950. In 2017, since her unearned income is over $2,100, the last $900 is taxed at your rate. The first $2,100 is taxed at her rate and her tax is $0. You save $315 (15% of $2,100) in the 15% LTCG bracket, but still must pay the tax on the $900 even though tax on $2,100 of LTCG was avoided. In 2018, the tax is imposed at the rate on trusts, and trusts pay 10% tax on the first $2600 of income, so there is no tax on the LTCG.

Example 4: Your child has no other income than $1,000 of LTCG from stock you gave him. His standard deduction is $1,050 and his taxable income is zero. You save $150 (15% of $1,000) in the 15% LTCG bracket.

Tax loss carryover
If a parent is in the 39.6% marginal income tax bracket and already has a $2,100 tax loss carryover, then a long-term capital gain of $2,100 will be offset by that $2,100 loss and no tax will be due. However, the $2,100 tax loss carryover could have been used to offset ordinary income in some cases and that would have saved 39.6% of $2,100 of about $832. Thus, gifting to a child may still make financial sense.