Kiddie Tax
IRS rules that tax a child's unearned income above a threshold at the parent's marginal tax rate.
What is Kiddie Tax?
The kiddie tax is a provision designed to prevent parents from shifting investment income to children to exploit the child's lower tax rate. Under current rules, the kiddie tax applies to children under age 19 and full-time students under age 24 who have more than a set threshold in unearned income (dividends, interest, capital gains). The first portion is tax-free, the next portion is taxed at the child's rate, and unearned income above the threshold ($2,600 for 2024) is taxed at the parent's marginal rate. Earned income such as wages is always taxed at the child's own rate.
Example
A 16-year-old has a custodial account generating $4,000 in qualified dividends. Under the kiddie tax, $2,600 is taxed at the parent's 32% marginal rate rather than the child's 0% rate, adding $832 to the family's federal tax bill. Only $1,400 of the dividends benefits from the child's lower tax rate.
Source: IRS Publication 929 — Tax Rules for Children and Dependents