Despite its name, the "kiddie tax" is anything but child's play. If you're not careful, this provision of the tax code can result in children having to pay significant extra tax dollars on their investment income. But your family may be able to downsize the kiddie tax for 2023 by making the right tax moves before year end.
For simplicity, throughout this article we use the terms "child" and "children" to apply to both children and young adults under age 24 who may be subject to the kiddie tax.
Background
Generally, income is taxed at the tax rate of the individual who receives it. For example, if you're in the top 37% tax bracket in 2023, any additional income you earn is taxed at the 37% rate. On the other hand, if your child is in the 10% bracket, the child pays tax at a maximum rate of only 10%.
However, a special rule applies to certain children who receive unearned income above an annual threshold. Under current law, the excess is taxed at the top marginal tax rate of the child's parents. Thus, instead of being taxed at the 10% rate, your child may be taxed at the 37% rate on the excess.
Unearned income includes the following types of income a child might receive during the year:
The source of the income doesn't matter. For instance, unearned income resulting from gifts of property by grandparents counts toward the kiddie tax. However, the tax doesn't apply to earned income, such as wages from a part-time job.
Initially, the kiddie tax only applied to children under 14, but the limit has been raised several times. Currently, the age limit is 19 (24 for a full-time student if the child doesn't have earned income in excess of half of their annual support). In other words, if your dependent child is in college, the kiddie tax likely still applies.
Important: The Tax Cuts and Jobs Act temporarily changed the way the kiddie tax was calculated. Previously, instead of using the parents' top tax rate, the tax was based on the income tax rates for trusts and estates. But Congress repealed this change under the SECURE Act of 2019.
The annual kiddie tax threshold is adjusted for inflation. For 2023, the first $1,250 is exempt from tax and the next $1,250 is taxed at the 10% rate. Therefore, the total kiddie tax threshold is $2,500. For example, if your 18-year-old has $5,000 in investment income in 2023, the first $1,250 is tax-free, the second $1,250 is taxed at 10% and the remainder ($2,500) is taxed at your marginal effective tax rate.
6 Tax Reduction Strategies
By being proactive, you can reduce your kiddie tax liability—or possibly eliminate it entirely. Consider the following six strategies:
How to Report the Tax
Many parents elect to report the kiddie tax on their own returns to simplify matters. If you make this election for 2023, your child won't have to file a tax return next year. If you're unable or unwilling to make this election, your child will be required to file a return if he or she receives unearned or earned income.
You must meet the following seven requirements to be eligible for this election:
We Can Help
Don't let the kiddie tax catch your family off-guard. If your child or grandchild has significant unearned income, contact your SSB tax advisor to identify strategies that will help reduce the kiddie tax for 2023 and beyond.
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