The Kiddie Tax was implemented to prevent parents from shifting investments or unearned income from their high tax bracket into their child’s lower tax bracket. Kiddie taxes work by taxing children’s unearned investment income at the parent’s tax rate rather than the lower rate for children.
For kiddie tax purposes, “unearned” or “investment” income is any income besides the child’s wages and earned salaries. It includes such assets as bank account interest, investment income, capital gains, and stock/mutual fund dividends. Thus, a parent who transfers such assets to their child will need to pay the kiddie tax.
How Does the Kiddie Tax Work?
The kiddie tax kicks in if the child’s net unearned income reaches over $1,900. The first half of this ($950) isn’t subject to taxes at all. The second $950 is taxed at the children’s rate, which may be 5 or 10% depending on the amount. Any amounts over $1,950 are taxed at the parent’s income tax rate, which may be anywhere from 10-35% depending on their income.
Who Does the Kiddie Tax Apply To?
The kiddie tax only applies to children who are:
- Unmarried and under 18 years old
- Under 18 years old with an earned income at least equal to half of the child’s support for the given tax year
- Full time students over 18 years old but not yet 24 at the end of the tax year, AND having an earned income of at least equal to half of the child’s support for the given tax year
How Can the Kiddie Tax Be Avoided?
There are a few ways that parents can make contributions to their children without being subject to the kiddie tax. These include:
- Section 529 “Qualified Tuition Plan” (QTP): Contributions to QTP’s aren’t tax deductible, so they aren’t subject to the kiddie tax. In addition, earnings aren’t counted as taxable income, so long as they are used for higher education costs. Withdrawals from such accounts need to be used for qualified educational purposes
- Education Savings Account (ESA): These are similar to QTP’s, except that they can be used for elementary and secondary school expenses. Contributions to ESA’s aren’t subject to kiddie taxes
- Employment: Another option is to hire your child if you own a business. Any wages you pay your own child won’t be subject to the kiddie tax
Many disputes and violations involving kiddie taxes can be avoided through proper planning and by consulting with qualified professionals. However, intentional conduct aimed at avoiding tax laws can lead to legal consequences for the parent. These can include fraud charges and other types of tax-evasion related violations, resulting in possible fines and/or jail sentences.
Do I Need a Lawyer for Assistance with Kiddie Tax Laws?
Kiddie tax laws are relatively new and can sometimes be confusing to understand. Legal questions and concerns should be directed to a qualified tax lawyer in your area. It’s in your best interests to hire an experienced attorney to help you with your tax inquiries. Kiddie tax laws aim to prevent abuses of the U.S. tax system and are strictly enforced.