Understanding the Kiddie Tax: A Guide for Parents Managing Children’s Investment Income
interest, dividends, or capital gains, it is often taxed differently from their parent’s income. In the United States, the kiddie tax rules apply to unearned income received by dependent children, ensuring that high investment returns cannot be used to avoid higher tax rates. For families living abroad or managing dual tax responsibilities, such as those in the UK, these rules can be even more complex.
What Is the Kiddie Tax?
The kiddie tax is a rule introduced to prevent parents from transferring investment income to their children, who are often taxed at lower rates. Instead, once a child’s unearned income exceeds a certain threshold, any excess is taxed at the parent’s marginal tax rate.
For 2024, the thresholds for unearned income are as follows:
The first $1,300 is tax-free due to the standard deduction for dependents.
The next $1,300 is taxed at the child’s rate (usually 10%).
Any income above $2,600 is taxed at the parent’s marginal rate.
These rules apply to:
Children under 18 years of age.
Children aged 18, or full-time students aged 19–23, whose earned income is less than half of their support costs.
How Does Kiddie Tax Work in Practice?
For example, consider a child with $5,000 in unearned income:
The first $1,300 is tax-free.
The next $1,300 is taxed at the child’s rate of 10%, resulting in $130 in tax.
The remaining $2,400 is taxed at the parent’s marginal rate, for example, 37% for high earners, resulting in $888 in tax.
The total tax owed would be $1,018, significantly higher than if all the income were taxed at the child’s lower rate.
Filing Options for Parents
Parents have two choices when reporting their child’s unearned income:
1. File a Separate Tax Return for the Child
The child must file their return (Form 8615) if their unearned income exceeds $1,300.
Tax is calculated using the child’s rate and the parent’s marginal rate as applicable.
2. Include the Income on the Parent’s Tax Return
Parents can elect to include the child’s income on their return using Form 8814 if the child’s total unearned income is less than $11,000.
The first $1,300 is tax-free, the next $1,300 is taxed at 10%, and the remainder is taxed at the parent’s rate.
While this simplifies the process, it may increase the parents’ overall tax liability.
Kiddie Tax and Cross-Border Families
For families living abroad, such as those in the UK, managing the kiddie tax alongside local tax rules introduces further complexities.
1. Income from Parental Gifts
In the UK, if parents gift money to their children and it generates income exceeding £100 annually, that income is taxed as the parents’ income. This rule prevents parents from avoiding tax by shifting investment income to their children.
2. Junior ISAs
While Junior ISAs are tax-free in the UK, they are not recognised as tax-free accounts in the US. Any income or gains from a Junior ISA must be reported on a US tax return and may be subject to the kiddie tax.
3. Exchange Rate Calculations
Unearned income denominated in foreign currency, such as GBP, must be converted into USD using the appropriate IRS exchange rate for tax reporting.
Case Study: Managing Kiddie Tax
Leon’s Scenario
Leon, a US citizen living in the UK, has set up an investment account for his 12-year-old daughter, Maya. The account earned $5,000 in interest and dividends during 2024. Tariq wants to know how this income will be taxed in both the US and UK.
In the US:
The first $1,300 is tax-free.
The next $1,300 is taxed at 10%, resulting in $130 in tax.
The remaining $2,400 is taxed at Tariq’s marginal rate of 37%, adding $888 in tax.
Total US tax: $1,018.
In the UK:
If the income exceeds £100 and was funded by Leon, it would be taxed as his income under UK rules. Maya would not owe UK tax on it.
Key Considerations
1. Minimising Tax Liability
Consider structuring investments to generate less unearned income during high-tax years or use tax-efficient vehicles that align with both US and UK tax rules.
2. Choosing the Right Filing Method
Assess whether it’s more beneficial to include the income on the parent’s return (Form 8814) or file a separate return for the child (Form 8615).
3. Cross-Border Planning
Families living abroad should consider the tax implications in both jurisdictions and seek advice to avoid double taxation or unexpected liabilities.
Conclusion
The kiddie tax ensures unearned income from dependents is taxed fairly, but it requires careful planning, particularly for families navigating both US and UK tax systems. Understanding how the thresholds and rules work can help parents manage their children’s investments while minimising tax burdens.
At Bambridge Accountants, we specialise in international and cross-border tax matters, helping individuals navigate complex rules around UK and US tax. For tailored advice on managing dependent income or cross-border tax issues, book a call with us.