What is the kiddie tax and what age does it apply to?

The kiddie tax under IRC 1(g) taxes a child's unearned income above a threshold at the parent's marginal tax rate. It applies to children under 19, or under 24 if they are full-time students, and covers income from trusts, UGMA/UTMA accounts, and other investment sources.

How does the kiddie tax affect UGMA and UTMA custodial accounts?

Distributions of unearned income from UGMA and UTMA custodial accounts to children subject to the kiddie tax are taxed at the parent's marginal rate, not the child's lower rate. This significantly reduces the tax benefit of shifting investment income to minors through custodial accounts.

The Kiddie Tax After TCJA: How It Affects Trusts and Gifts to Minors | Lynch Law

The kiddie tax — the colloquial name for IRC § 1(g) — has been part of the tax landscape since 1986, but the Tax Cuts and Jobs Act made it more complex and, for a brief period, significantly more punitive. While Congress reversed the most controversial TCJA change in 2019, the kiddie tax remains a trap for families using trusts and custodial accounts to shift income to children. Understanding how the kiddie tax works in its current form is essential for anyone involved in estate planning that involves transfers to or for the benefit of minors.^[1]

How the Kiddie Tax Works

The kiddie tax applies to the "net unearned income" of a child who is under age 19 at the close of the tax year, or under age 24 if the child is a full-time student. Unearned income includes interest, dividends, capital gains, rents, royalties, and — critically — taxable distributions from trusts. The first $1,250 of unearned income (2024 amount, indexed for inflation) is offset by the child's standard deduction. The next $1,250 is taxed at the child's own rate. Everything above $2,500 is taxed at the parents' marginal rate.

The effect is to eliminate the tax benefit of shifting investment income to a child in a lower bracket. Before the kiddie tax, a parent in the 37% bracket could transfer income-producing assets to a child who would pay little or no tax on the income. The kiddie tax closes this by imputing the parent's rate to the child's unearned income above the threshold.

The TCJA Detour and Correction

The Tax Cuts and Jobs Act of 2017 changed the kiddie tax calculation for tax years 2018 and 2019. Instead of applying the parents' marginal rate to the child's excess unearned income, the TCJA applied the compressed trust and estate tax brackets — which reach the top 37% rate at just $13,050 of taxable income (2018 amount). This meant that many children paid a higher effective rate than their parents would have, because the trust brackets are far more compressed than the individual brackets.^[2]

The result was an unexpected tax increase for military families receiving survivor benefits (Gold Star families) and for other families with children receiving unearned income. Congress responded with the SECURE Act of 2019, which retroactively repealed the TCJA change and restored the pre-TCJA rule of taxing the child's unearned income at the parents' rate. Families had the option of applying either the TCJA rule or the pre-TCJA rule for 2018 and 2019, and should choose whichever produces the lower tax.

Interaction with Trusts

The kiddie tax has a direct impact on the taxation of trust distributions to minor beneficiaries. When a trust distributes income to a beneficiary, the trust takes a distribution deduction and the income is taxable to the beneficiary. If the beneficiary is a child subject to the kiddie tax, that distributed income is classified as unearned income and taxed at the parents' rate to the extent it exceeds the kiddie tax threshold.

This interaction undermines one of the traditional motivations for creating trusts for minors — income tax savings. A trust that accumulates income pays tax at the highly compressed trust rates (reaching 37% at just $14,450 of taxable income in 2024). But distributing the income to the child beneficiary does not solve the problem if the child is subject to the kiddie tax, because the distributed income will be taxed at the parents' rate rather than the child's rate.^[3]

The planning implications are significant. For trusts holding income-producing assets for the benefit of minor children, the trustee must consider whether distributing income will trigger the kiddie tax and, if so, whether the parents' rate is lower than the trust rate (it usually is, because the trust brackets are more compressed). In most cases, distributing income to a child subject to the kiddie tax still produces a better result than accumulating it in the trust — but the savings are much smaller than they would be if the kiddie tax did not apply.

UGMA and UTMA Accounts

Custodial accounts under the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) present similar issues. Income earned in a custodial account is taxable to the child, and if the child is subject to the kiddie tax, the unearned income above the threshold is taxed at the parents' rate. This limits the income-shifting benefit of UGMA/UTMA accounts for families in higher brackets.

Parents and grandparents considering contributions to custodial accounts should weigh the kiddie tax implications against other options. A 529 education savings plan, for example, allows tax-free growth and tax-free withdrawals for qualified education expenses, without triggering the kiddie tax. A Roth IRA (if the child has earned income) also avoids the kiddie tax on accumulated earnings. For families whose primary goal is education funding, these alternatives may be more tax-efficient than UGMA/UTMA accounts.

Planning Considerations

Despite the kiddie tax, there are legitimate reasons to hold assets in trust for minor beneficiaries — asset protection, control over distributions, and the ability to provide for the child's needs without giving the child direct access to the funds. The kiddie tax does not eliminate the non-tax benefits of trusts; it merely reduces the income tax advantage of shifting income to children.

For families engaged in multigenerational tax planning, the kiddie tax is one of several constraints that must be navigated. Working with counsel who understands the interaction between the kiddie tax, trust income taxation, and the broader estate plan is essential to achieving the best overall result. The kiddie tax is not an insurmountable obstacle — it is a planning constraint that, when properly accounted for, can be managed effectively.^[4]

References

^[1] IRC § 1(g) (tax on certain unearned income of children). The kiddie tax was enacted as part of the Tax Reform Act of 1986 to prevent income shifting to children in lower tax brackets.
^[2] Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 11001(a) (2017) (applying trust and estate tax rates to kiddie tax income for 2018-2019); SECURE Act, Pub. L. No. 116-94, § 501 (2019) (retroactive repeal of TCJA kiddie tax change).
^[3] IRC § 1(e) (trust and estate tax brackets: 37% rate applies at $14,450 of taxable income for 2024); compare IRC § 1(j) (individual brackets: 37% rate applies at $609,350 of taxable income for single filers in 2024).
^[4] See also IRC § 529 (qualified tuition programs: tax-free growth and distributions for qualified education expenses); IRC § 408A (Roth IRAs: tax-free growth for children with earned income).