The federal kiddie tax applies when a child’s unearned income exceeds the amount of the dependent’s standard deduction and the child meets specific age and support tests. The rule was created to prevent shifting investment income to children to take advantage of their typically lower tax rates and is codified in Internal Revenue Code Section 1g enacted by the U.S. Congress. Official guidance appears in Publication 929 by the Internal Revenue Service, which explains who qualifies and how the income is taxed.
Age and support tests
A child triggers the kiddie tax only if the child is subject to the age and support criteria set by the tax code. The child must be under a specified age at the end of the tax year or be a full time student under a higher age limit, and the child must not provide more than half of his or her own support with earned income. These tests determine whether investment income such as dividends, interest, and capital gains count as the kind of unearned income that can be recharacterized under the kiddie tax rules. The Internal Revenue Service guidance outlines these definitions and the filing thresholds that determine when a separate return is required.
Tax calculation and consequences
When the kiddie tax applies, the child’s unearned income above the dependent standard deduction is taxed at rates defined in the tax code rather than at the child’s normally lower rates. Under current law the statutory formula for computing the tax is set in the Internal Revenue Code Section 1g and interpreted by the Internal Revenue Service in Publication 929. A practical consequence is that families using investment accounts to shift taxable income to minors may face higher aggregate tax bills than anticipated. The tax can also affect financial aid calculations for higher education since investment income can reduce expected family contribution.
There are procedural options that can change how the tax is handled, including a parental election in limited circumstances using a separate form to include the child’s qualifying interest and dividends on the parent’s return. State tax treatment may differ from federal rules, so the same income can have different effects in different jurisdictions. For authoritative detail consult Internal Revenue Service Publication 929 and the Internal Revenue Code Section 1g as interpreted by the U.S. Congress and the Internal Revenue Service.