Kiddie tax

Kiddie tax

Do your kids have assets that can generate income in a custody account? If so, ensure you know the ‘kiddie tax’. High-income households have traditionally passed unearned money via their children to reduce their overall taxes.  

The kiddie tax, which the IRS introduced in the 1980s to reduce the effectiveness of this strategy by taxing specific amounts of children’s unearned income at a very high rate, was never well received. The kiddie tax is a crucial subject to comprehend if you’re a college student who has been building an investment portfolio or the parent of a future investor.

What is the kiddie tax? 

In 1986, a special tax law known as the “kiddie tax” was established to resolve investment and unearned income tax issues for people 18 or younger and dependent full-time students under 24. 

 The tax was intended to penalise parents who might attempt to benefit from their child’s reduced tax rate. It was designed to deter parents from giving ownership of their assets that generate income to a child in a far lower tax bracket. 

Understanding kiddie tax 

Even if your children are too young to vote, this does not excuse them from paying taxes. The IRS is interested in knowing about all income, whether from a person’s work or investments. They may even wind up owing the IRS money based largely on what their parents make, depending on the sums at stake. 

 The kiddie tax’s basic idea is that all unearned income for children must be taxed at the child’s lower rate up to a specific threshold. And, any sum over that limit will be subject to taxation at the parent’s or guardian’s marginal rate.  

 The rate at which unearned income is taxed depends on which parent makes more money. The kiddie tax is triggered if your child receives more than a particular amount in interest, dividends, or other unearned income. 

How does the kiddie tax work? 

The IRS established strict limitations on the types of income and tax rates. Up to a maximum of US$13,850 in 2023, children’s earned income will be taxed at their appropriate standard deduction rate plus US$400 (or US$1,250, whichever is larger). The method for investment income, however, is more complex. The IRS has established tiers for taxing unearned income from dividends, interest, and capital gains. 

 In 2023, up to US$1,250 in unearned income for a kid without earned income is exempt from taxation. The following US$1,250 is subject to child taxation. The tax rate for parents is applied to any sum over US$2,500. These regulations cover children under 18 and full-time students up to 24. 

History of the kiddie tax 

The kiddie tax regulation initially applies to unearned income and investments made by children under 14. The children get money through gifts, dividends, and bond interest because they cannot obtain work. The age was raised from 14 to 16 and 18 years after the government learned that people were using this tax provision to escape taxes.  

 Moreover, the kiddie tax threshold was set at US$1,050 as of 2017, and income below that level was taxed at the child’s rate, while income above that amount was taxed at the guardian’s rate. The Tax Cuts and Jobs Act, passed in 2018, brought about several changes to the kiddie tax.  

 For 2022, the standard deduction was available for the first US$1,150 of unearned income received by a child; the following US$1,150 was subject to the child’s income tax rate; and unearned income of more than US$2,300 was subject to the parent’s marginal income tax rate. These limitations were US$1,250 and US$2,500 for the tax year 2023. 

Who and what the kiddie tax applies to? 

The kiddie tax is only levied on children who are under the age of 18 at the end of the tax year; children under the age of 19 who do not provide more than half of their support through earned income; and children under the age of 24 who are full-time students and whose earned income does not exceed half of the annual expenses for their support.  

A child must attend school full-time for at least five months out of the year to be classified as a student. Whether the youngster is shown as a dependent on the parent’s tax return is irrelevant. However, a child under 24 who is married and submits a joint tax return is exempt from the tax.  

Only unearned income that a child receives from assets that generate income, such as cash, stocks, bonds and real estate, are subject to the kiddie tax. The kiddie tax laws do not apply to any payment or wages that a child makes through a full- or part-time job; as a result, that income is taxed at the child’s ordinary income tax rate. 

Frequently Asked Questions

The kiddie tax threshold in the United States is $2,100. If a child has an investment income of more than $2,100 a year, the child will be taxed at the parent’s tax rate. The kiddie tax applies to children under 18, as well as to 19- and 20-year-olds who are full-time students. 

 

Children under 18 and dependent full-time students between 19 and 24 are subject to the kiddie tax. 

Supporting requirements specify crucial system quality characteristics like performance, usability, dependability, and global functional requirements not reflected in behavioural requirements artefacts like use cases. 

As of 2023, the kiddie tax rules in the United States are as follows: 

  • Children under the age of 18 are subject to the kiddie tax if they have an unearned income of more than US$2,100. 
  • The tax rate for unearned income above US$2,100 is 37% (the highest marginal tax rate for individuals) 

The child’s taxable income is calculated as follows:  

Child’s net earned income + Child’s net unearned income – Child’s standard deduction.  

The child’s earned income will be taxed at the standard rate, and unearned income beyond US$2,200 will be assessed at fixed rates. Different tax rates apply to different types of income, including long-term capital gains. The rates are 0% up to US$2,650;  15% from that amount to US$12,950; and 20% over that amount. 

 

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