The Kiddie Tax: How to Shield Your Child’s Investment Income from the IRS
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Result: Asset selection saved nearly $1,000 in annual taxes.
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The Kiddie Tax: How to Shield Your Child’s Investment Income from the IRS
CORE INSIGHTS
- The Trap: The “Kiddie Tax” taxes a child’s unearned income above ~$2,700 (2025) at the parents’ highest rate. This blocks simple income shifting.
- The Safe Zone: The first $1,350 is tax-free. The second $1,350 is taxed at the child’s low rate (10%). Staying under this limit ($2,700) is key.
- Strategic Asset Location: To avoid the tax, hold Growth Stocks (no dividends) or Muni Bonds in the child’s account. Defer gains until adulthood.
Investing for your children is smart, but the IRS has a safeguard: the Kiddie Tax (Form 8615). If a child’s investment income exceeds the threshold, it is taxed at your rate (up to 37%). Asset location is critical to avoid this penalty.
What-If Scenario: The Dividend Mistake ($100k)
| Strategy | Yield / Income | Tax Bill |
|---|---|---|
| High Yield Bond (5%) | $5,000 Income | $986 (Parents’ Rate) |
| Growth ETF (0.5%) | $500 Income | $0 (Tax-Free) |
Visualizing the Tax Cliff
*Figure 1: The Tax Staircase. Income above the Red line triggers the Parents’ Rate.*
Strategic Action Steps
1
Audit UTMA Accounts
Check your child’s custodial account. If they hold high-dividend stocks, swap them for Broad Market Growth ETFs (VUG) to minimize taxable distributions.
Check your child’s custodial account. If they hold high-dividend stocks, swap them for Broad Market Growth ETFs (VUG) to minimize taxable distributions.
2
Gain Harvesting (#111)
Every year, realize enough gains to fill the $2,700 “Safe Zone” (after dividends). This steps up the basis tax-free annually.
Every year, realize enough gains to fill the $2,700 “Safe Zone” (after dividends). This steps up the basis tax-free annually.
3
Switch to 529s
If the balance is >$50k, stop adding to UTMA. Use a 529 Plan (#114). 529 earnings are never taxed federally, bypassing the Kiddie Tax entirely.
If the balance is >$50k, stop adding to UTMA. Use a 529 Plan (#114). 529 earnings are never taxed federally, bypassing the Kiddie Tax entirely.
The Bottom Line: Who Should Choose What?
- Use UTMA: For small balances (<$25k) invested in growth stocks. Flexibility outweighs tax risk.
- Use 529/Roth: For large balances. The tax shield is necessary to prevent erosion.
Frequently Asked Questions
What is the 2025 Kiddie Tax threshold?
For 2025, the first $1,350 is tax-free. The next $1,350 is taxed at the child’s rate (10%). Any unearned income over $2,700 is taxed at the parents’ rate.
Does this apply to wages?
No. Wages (Earned Income) are taxed at the child’s rate and get the standard deduction ($14,600). Kiddie Tax applies only to investment income.
How can I avoid the tax?
Invest in assets that don’t produce income (Growth Stocks) or tax-free assets (Municipal Bonds). Defer gains until the child is an adult.
Disclaimer: This content is for informational purposes only. Tax thresholds change annually. Consult a tax professional.