Today, we will discuss the Kiddie Tax, a special tax rule that applies to certain unearned income of children. The Kiddie Tax was implemented to prevent parents from shifting income to their children to take advantage of the child’s lower tax bracket.
What is the Kiddie Tax?
The Kiddie Tax applies to the unearned income of certain children, taxing the portion exceeding a specific threshold at the parent’s tax rate.
Children Subject to the Kiddie Tax:
The Kiddie Tax may apply to a child who meets either of the following conditions:
- The child is under age 17 at the end of the tax year.
- The child is age 18 or older but under age 24 at the end of the tax year and is a student whose earned income is less than half of their own support.
Taxation of Unearned Income (Based on 2024)
For the 2024 tax year, a child’s unearned income is taxed as follows:
- Up to $1,300: No tax is imposed (standard deduction).
- Between $1,301 and $2,600: Taxed at the child’s tax rate.
- Over $2,600: The excess amount is taxed at the parent’s marginal tax rate.
Key Takeaway: Unearned income exceeding $2,600 is taxed at the parent’s higher tax rate, potentially increasing the tax liability.
Tax Calculation Example
Let’s assume a 15-year-old child has the following unearned income in 2024:
- Interest income: $3,500
- Stock dividends: $1,500
- Total unearned income: $5,000
The Kiddie Tax would apply as follows:
- Tax-free amount: $1,300
- Taxed at the child’s rate: $2,600 - $1,300 = $1,300
- Taxed at the parent’s rate: $5,000 - $2,600 = $2,400
Therefore, $1,300 of the unearned income will be taxed at the child’s tax rate, and $2,400 will be taxed at the parent’s marginal tax rate.
How to Calculate the Kiddie Tax
Here’s a step-by-step approach to calculating the Kiddie Tax:
- Calculate the child’s total unearned income.
- Determine the amount exceeding $2,600 (for 2024). This is the income subject to the parent’s tax rate.
- Identify the parent’s marginal tax rate based on their taxable income and tax liability.
- Multiply the excess amount (from step 2) by the parent’s marginal tax rate to calculate the tax on that portion.
- Calculate the tax on the unearned income between $1,301 and $2,600 using the child’s tax rate.
- Add the tax amounts calculated in steps 4 and 5 to arrive at the child’s total tax on unearned income.
Important Note: Calculating the Kiddie Tax can be complex. It’s advisable to consult a tax professional for accurate tax computation.
Conclusion
The Kiddie Tax is an important provision designed to prevent high-income parents from avoiding taxes by shifting income to their children.