The kiddie tax: when your child's investments get taxed at your rate

There's an old tax strategy so obvious that Congress banned it in 1986: shift income-producing investments into your kids' names, let the gains be taxed at their near-zero rate, and keep the money in the family. The ban is called the kiddie tax, and it's still catching families off guard four decades later — usually the ones who generously overfunded a custodial account and then sold something. If your child has investment income, you need to know where the lines are.

The three brackets of a child's unearned income

The kiddie tax applies only to unearned income — interest, dividends, capital gains, and distributions. For 2025 the structure works in three tiers, with thresholds that inch up with inflation each year (expect roughly $1,350 tiers for 2026):

• The first ~$1,350 of unearned income: completely tax-free, covered by the dependent's standard deduction against unearned income.
• The next ~$1,350: taxed at the child's own rate — typically 10% for ordinary income, and often 0% for qualified dividends and long-term capital gains.
• Everything above ~$2,700: taxed at the parents' marginal rate, as if the parents had earned it themselves. For a family in the 32% bracket, that's 32% on the child's interest income instead of the child's 10%.

Earned vs. unearned: the distinction that decides everything

Wages from a job are never subject to the kiddie tax — a 17-year-old can earn $20,000 lifeguarding and it's all taxed at her own low rates. The kiddie tax targets only investment income, and it generally follows the child until age 18, or through age 23 if they're a full-time student who doesn't provide more than half of their own support from earned income. That last clause surprises people: a 22-year-old college senior with a trust distribution or a big custodial account sale is very likely still inside the kiddie tax regime.

Form 8615 and how it actually gets reported

When a child's unearned income exceeds the annual threshold (about $2,700), Form 8615 gets attached to the child's own tax return, and it calculates the tax using the parents' top rate — which means you can't finish the kid's return until the parents' return is done. Alternatively, if the child's income is only from interest and dividends and stays under a modest cap (about $13,500), parents can elect to report it directly on their own return using Form 8814. That election is convenient but frequently costs money: it can push income onto the parents' state return, inflate their AGI (affecting credits and phaseouts), and forfeit the child's favorable capital gains treatment. When in doubt, file the child's own return with Form 8615.

Strategies to manage the kiddie tax

1. Harvest gains annually up to the threshold. Selling and immediately repurchasing appreciated funds in the custodial account each year 'uses up' the ~$2,700 of low-tax room and resets the cost basis higher. There's no wash-sale problem with realizing gains.
2. Prefer growth over yield inside custodial accounts. Broad stock index funds throwing off 1.5% in dividends generate far less annual kiddie-taxable income than bond funds or REITs. Save the income-heavy assets for parent accounts.
3. Use 529 plans for education money. 529 growth is never taxed when spent on qualified education — the kiddie tax simply doesn't apply.
4. Fund a custodial Roth IRA when the child has earned income. Growth inside the Roth is invisible to the kiddie tax forever.
5. Time big liquidations across multiple tax years, and where possible avoid large sales during the aid-formula years if college aid is in play.
6. Consider direct tuition payment. Money a grandparent pays straight to a school is gift-tax-free in unlimited amounts and never creates income in the child's name at all.

The tiers at a glance

The table makes the planning target obvious: keep each year's realized unearned income at or under the ~$2,700 line, where the blended tax rate rounds to almost nothing, and never let a single year absorb gains that could have been spread across several. Families who internalize those two rows save four figures on the same underlying investments.

The bottom line

The kiddie tax doesn't make custodial accounts bad — it makes them a tool with a speed limit. Keep annual unearned income near the ~$2,700 threshold, harvest gains every year while the low brackets are free, hold growth assets instead of income assets, and route education money through a 529 where the rules don't reach. Families who respect the thresholds pay almost nothing; families who discover Form 8615 in April pay their own top rate on their kid's money.