Kiddie Tax Definition

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Kiddie Tax Definition

What Is the Kiddie Tax?

The kiddie tax is a special tax legislation enacted in 1986 to handle investment and unearned income taxes for people under the age of 18—or dependent full-time students under the age of 24.

Key Takeaways

  • The kiddie tax prohibits parents from evading taxes by making big stock donations.
  • Over the threshold, all unearned income is taxed at the parent’s marginal income tax rate rather than the lower child’s tax rate.
  • It applies to all children under the age of 18 and dependent full-time students between the ages of 19 and 24.
  • The kiddie tax applies to the majority of unearned income received by a child and does not apply to any salary or wages.
  • Under the child tax code, unearned income under $1,150 qualifies for the standard deduction in 2022.

How the Kiddie Tax Works

Individuals under a specific age (18 years old or less, and full-time students aged 19-24 years old) who have investment and unearned income that exceeds an annually decided level are subject to the kiddie tax.

This law is intended to prohibit parents from taking advantage of a tax loophole by making significant stock gifts to their children. In this situation, the kid would realize any profits from the investments and would be taxed at a far lower rate than the guardians would face for realized stock gains.

All unearned income over the threshold is taxed at the parent’s marginal income tax rate rather than the child’s tax rate under the kiddie tax legislation. Unearned income of less than $1,100 is eligible for the standard deduction in 2021. The following $1,100 is taxed at the child’s tax rate, which may be as low as 0%, and everything beyond $2,200 is taxed at the guardian’s tax rate, which can be as high as 37%.

  After-Tax Income Definition

Unearned income under $1,150 eligible for the standard deduction in 2022, with the following $1,150 taxed at the child tax rate.

Who and What the Kiddie Tax Applies to

The kiddie tax will be implemented in 2021 for all children aged 18 and under at the conclusion of the tax year, as well as children who are dependent full-time students between the ages of 19 and 24. It does not, however, apply to children under the age of 18 who are married and submit joint tax returns.

The kiddie tax applies to any unearned income received by a child, including interest, dividends, capital gains, rent, and royalties. The kiddie tax does not apply to any income or earnings earned by the child.

Adult children who reach 19 at the end of the tax year (or 25 in the case of dependent full-time students) are exempt from the kiddie tax.

History of the Kiddie Tax

Initially, the tax legislation only applied to children under the age of 14. Children under the age of 14 are not legally allowed to work, thus any money they get is mainly in the form of dividends or bond interest. However, tax officials noticed that some guardians would use the circumstance and subsequently make stock presents to their older, 16-to-18-year-old offspring.

Individuals 18 years old or younger who have investment and unearned income that exceeds a yearly established level are subject to the kiddie tax. The IRS taxes any income beyond a certain level at the parent’s tax rate. The Tax Cuts and Jobs Act of 2017 temporarily altered the kiddie tax to utilize estate and trust tax rates rather than the child’s parents’ tax rate.

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However, the Further Consolidated Appropriations Act 2020 restored it to the parent’s tax rate retrospectively. For 2018 and 2019 returns, taxpayers may calculate the kiddie tax using either the estate tax rates or the parent’s take rate. The parent’s tax rate applies in 2020 and beyond.

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