The Kiddie Tax: What Parents Need to Know Before Shifting Wealth to Their Kids

As parents, it’s natural to want to set your children up for financial success. That might mean helping them invest early or even shifting assets into their name to take advantage of their lower tax bracket. But before you move dividend-paying stocks or other income-generating assets to your child’s account, there’s one tax rule you need to understand: the Kiddie Tax.

Here’s what it is, how it works, and how to avoid the most common mistakes families make.

What is the Kiddie Tax?

The Kiddie Tax is a set of IRS rules designed to prevent income shifting — that is, the act of moving investments or other income-generating assets to a child’s account to pay lower taxes.

If your child has unearned income above a certain threshold, that income will be taxed at your tax rate, not theirs.

Who Does the Kiddie Tax Apply To?

The Kiddie Tax applies to:

Children under age 18
Full-time students ages 19–23 who don’t provide more than half of their own financial support

If your child fits into one of these categories and has unearned income, the Kiddie Tax likely applies.

2025 Kiddie Tax Thresholds

For 2025, here’s how the Kiddie Tax breaks down:

First $1,300 of unearned income: Tax-free
Next $1,300: Taxed at the child’s rate
Income above $2,600: Taxed at the parents’ marginal rate

This means a child with $5,000 in investment income could have roughly half of that taxed as if it belonged to the parents — erasing the benefit of income shifting.

What Counts as Unearned Income?

The Kiddie Tax applies only to unearned income, including:

Dividends
Interest
Capital gains
Rental income
Royalties

Earned income, such as W-2 wages from a summer job, is not subject to the Kiddie Tax. That difference is critical.

Bad vs Smart Wealth Transfer: A Real Example

Let’s compare two approaches parents might take:

❌ The Tax Trap:

A parent gifts $50,000 in dividend-paying stocks to a custodial account for their 17-year-old. The investments generate $5,000 in annual dividends.

Result:

First $1,300 = tax-free
Next $1,300 = taxed at child’s rate
Remaining $2,400 = taxed at parent’s rate (likely 24–37%)

This “tax-saving” strategy ends up backfiring, leading to little or no actual savings.

✅ The Tax-Smart Path:

The same child earns $6,500 from a part-time job. The parent helps open a Roth IRA, funded with that earned income. Investments are made inside the Roth.

Result:

No Kiddie Tax (earned income is exempt)
No tax on investment growth
No tax on withdrawals in retirement (if qualified)

That one Roth contribution — just $6,500 at age 17 — could grow to $93,000+ tax-free by age 60 assuming a 7% average annual return.

How to Plan Around the Kiddie Tax

Here are a few practical takeaways for families:

Be aware of the $2,600 unearned income limit before gifting income-producing assets
Consider 529 plans for tax-advantaged college savings (not subject to Kiddie Tax)
Use earned income to fund Roth IRAs for your kids
If gifting investments, focus on growth assets that may not produce annual taxable income

Final Thoughts

The Kiddie Tax doesn’t mean you shouldn’t help your kids invest or build wealth — it just means you need to do it thoughtfully. With the right approach, you can support their financial future without inviting unnecessary taxes today.

At Abbey Street, we help families navigate multi-generational planning opportunities with a clear eye on tax strategy. If you’re considering wealth transfers, we’d be happy to help you evaluate the smartest, most efficient way to do it.

Let’s start a conversation.

Learn More

IRS.gov – https://www.irs.gov/taxtopics/tc553

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