THE KIDDIE TAX is designed to prevent parents from transferring large sums to their children with the goal of saving on taxes. In 2020 and 2021, the first $1,100 of a child’s investment gains are tax-free and the next $1,100 are taxed at the child’s rate. Any investment gains above $2,200 are taxed at the parents’ rate.
The kiddie tax typically applies to children under age 18 or, if they don’t have much income from employment, under age 19. It also applies to young adults under age 24 who were fulltime students as of year-end. Instead of filing a separate tax return for a child, parents may be able to include the kid’s investment gains on their own tax return. That way, you avoid filing an extra tax return, but arguably it isn’t any simpler.
While the kiddie tax was a big issue in the 1990s, when many parents used custodial accounts to save for college, it shouldn’t be as big an issue today. Why not? If you save for college, you now have two great college savings options available to you: 529 college savings plans and Coverdell education savings accounts. Neither account, with their potential tax-free growth, would trigger the kiddie tax.
What if you want to invest in a child’s name with the goal of helping him or her save money for after college? To sidestep the kiddie tax, you might invest in a way that’s likely to generate less than $2,200 a year in annual investment gains. For instance, you could favor tax-efficient investment vehicles like stock index mutual funds or tax-managed stock funds.
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