What is the kiddie tax?

Using custodial accounts (such as a child’s savings or investment account) to gift assets to children and grandchildren is one way to potentially reduce your income taxes. This strategy allows you to shift income into the child’s lower tax bracket while also removing assets from your taxable estate.

However, the tax benefits of this strategy are limited due to what’s commonly referred to as the “kiddie tax.”

What is the kiddie tax?

The kiddie tax isn’t a separate tax. Instead, it’s a special set of tax rules established to prevent families from taking advantage of a tax loophole by using custodial accounts as a tax shelter.

According to Dan Willing, Senior Wealth Strategist with U.S. Bank Private Wealth Management, the laws creating the kiddie tax were enacted as part of the 1986 Tax Reform Act to curtail income-shifting strategies like this.

“Under the kiddie tax rules, children’s unearned income above a certain threshold is taxed at the parent’s marginal tax rate,” says Willing. Marginal tax rates currently range from 10% to 37% depending on your income.

The legislation defines a child as anyone who is under age 18 or a full-time student who is under age 24. For kiddie tax purposes, unearned income includes:

• Interest
• Dividends
• Capital gains
• Taxable scholarships
• Income produced by custodial accounts under the UGMA

2025 kiddie tax rules

If you’re considering gifting assets to your children or grandchildren, it’s important to understand when the kiddie tax kicks in. In 2025:

• The first $1,350 of a child’s unearned income (as defined above) qualifies for the kiddie tax standard deduction and is not taxed.
• The next $1,350 is taxed at the child’s marginal tax rate, which is 10% if the child’s adjusted gross income is less than $11,295 in 2025.
• Any unearned income above $2,700 is taxed at the parent’s marginal tax rate.

Willing says that there are a few exceptions to these rules. The kiddie tax does not apply if a child:

• Has earned income that totals more than half of their support.
• Is married and files a joint tax return.
• Is a full-time student between 19 and 23 years old and has earned income that is greater than or equal to half of their support.

Support includes food, clothing, shelter, healthcare and tuition, while earned income includes wages, salaries, tips and other compensation for personal services.

The kiddie tax also doesn’t apply if a child had no living parents at the end of the tax year or is not required to file a tax return for the year.

If a child has earned income, such as from a summer job, the rules get more complex. “In this case, it’s usually smart to consult a tax advisor for guidance,” Willing says.

Impact of the kiddie tax on your monetary gifts

This example helps to illustrate the potential impact of the kiddie tax.

Suppose you opened a custodial account and purchased stock shares for your child, and they received $10,000 in dividends, interest and capital gains from the shares (unearned income). They have no earned income to report.

• The first $1,350 of unearned income is tax free.
• The next $1,350 is taxed at your child’s marginal rate. At a rate of 10%, the tax would be $135.
• The remainder of the unearned income ($7,300) is taxed at your marginal rate. If that were 24%, the tax would be $1,752.

All in, the tax on your child’s $10,000 of unearned income would come to nearly $2,000 ($135 + $1,752 = $1,887).

How to report the kiddie tax

You can report the kiddie tax in one of two ways:

1. The child files their own tax return.

If the child’s unearned income is greater than $2,700 in 2025, they can file their own tax return using Form 1040 and attach IRS Form 8615, “Tax for Certain Children Who Have Unearned Income.” The form will calculate how much tax is due using the parent’s marginal tax rate for income above the $2,700 threshold.

2. You include your child’s unearned income on your tax return.

If the child’s gross income (their income before taxes and deductions) is less than $13,500 in 2025, this income can be included on the parent’s tax return using IRS Form 8814, “Parents’ Election to Report Child’s Interest and Dividends.” While this may simplify the tax-filing process, it could increase the parents’ taxable income.

How to avoid the kiddie tax

Willing says the best way to avoid paying the kiddie tax in 2025 is to avoid generating income that’s subject to the tax. “There are usually better ways to accomplish tax saving goals than by outright gifting assets to children,” he says.

One option is to invest in a tax-advantaged account like a 529 college savings plan or help your child with earned income contribute to a Roth IRA, so earnings grow tax-free or are subject to more favorable tax treatment.

Another is to prioritize investments that generate minimal taxable income, such as tax-free municipal bonds or growth stocks that focus on capital appreciation instead of paying dividends.

Willing prefers irrevocable trusts to custodial accounts for purposes of generational wealth transfer. “These can be set up in ways that are tax-efficient and allow more control over when distributions occur,” he says. “They provide much more significant guardrails than custodial accounts.”

Kiddie tax planning

The details of gifting as a strategy to reduce income taxes can get complex when the kiddie tax is factored in. You should speak with your tax and financial professional for guidance in your specific situation.

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