Despite its name, the “kiddie tax” doesn’t apply just to children in diapers or elementary school. In fact, it may even cause tax complications for parents of twenty-somethings.
Kiddie Tax Rule
As a general rule, income is taxed to the taxpayer who receives it at his or her appropriate tax rate. For example, if you’re in the top 39.6% tax bracket, any extra income you receive is taxable to you at the 39.6% rate. Conversely, if your young child is in the lowest 10% bracket, the child is taxed at the 10% rate on income within the bracket.
But the kiddie tax is triggered if “unearned income” (i.e., investment income) of certain children exceeds an annual threshold. The threshold, which is $2,000 on 2013 returns, remains the same in 2014. In this case, the excess income is taxed at the top rate of the child’s parents — no matter the source of the unearned income.
Important Ages for the Kiddie Tax
Initially, the kiddie tax only affected children under age 14, but the age limit has been boosted several times over the years. Currently, the tax applies to your child who is under age 19, or a full-time student under age 24, if the child may be claimed as a dependent on your tax return. Thus, you still may have to pay the kiddie tax for a high school graduate who is working or a college senior.
To avoid or reduce kiddie tax liability, monitor your child’s investments, trying to stay below or near the $2,000 threshold. When appropriate, have your child invest in tax-free municipal bonds or growth stock that doesn’t produce current income. Other investment alternatives are CDs and Treasuries maturing in the future. Don’t let the kiddie tax govern your investment decisions, but don’t forget to take it into account.