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Why Do My Kids Pay So Much Tax?
Published Date : January 29, 2025
“What’s the best way to use our money to maximize our happiness?” Harvard Business School professor, Dr. Michael Norton, sought to answer this question in a 2013 research study and found “people who spend money on others report greater happiness.”1 When it comes to our children, small gifts over time can make a significant impact. Beyond the transformative power of compound interest and growth, gifting to the young ones in our lives can teach them to be responsible with money. However, in addition to the annual gift tax exclusion of $19,000 per recipient in 2025 ($38,000 per married couple), there is another, often misunderstood, tax consideration—the kiddie tax.
What is the kiddie tax and who is a “kiddie”?
The kiddie tax was “born” on October 22, 1986, as part of the Tax Reform Act. Signed into law by President Ronald Reagan, it was designed to close a tax loophole that parents had been using to transfer income-producing assets to their children, taking advantage of their lower tax rates. This aptly named tax applies to dependent children under 19 or full-time students under 24 who receive unearned income above a threshold ($2,700 in 2025), which becomes taxable at the parent’s tax rates. The IRS defines unearned income as “investment-type income such as taxable interest, ordinary dividends, and capital gain distributions.” As a result, the kiddie tax may produce an income tax liability for the family as a whole, but you may be able to limit this with some astute planning.
How does this work in real life?
These “kiddies” pay no tax on the first $1,350 of unearned income, then are subject to their own marginal tax rate for the next $1,350. Beyond the total kiddie tax threshold of $2,700, their income is taxed at their parent’s marginal tax rate. In a real-life example, 14-year-old Charlie isn’t (yet) working, but received a gift of stock from Uncle Bob that produces $6,000 in annual dividends. Since this is over the threshold amount of $2,700, the kiddie tax would apply. Specifically, the first $1,350 of dividend income would be tax-free, the next $1,350 would be taxable at Charlie’s 10% rate, and the additional $3,300 becomes taxable at his parent’s marginal rate.
Now that we have a better understanding of how the kiddie tax is applied, how can this impact our gifting decisions? Being mindful that the unearned income received is below the kiddie tax limit each year is a great place to start. Another is investment selection, generally focusing on assets that minimize taxable income. Speak to your Sand Hill team if you have any questions about appropriate investments for your child’s situation. By seeking professional guidance from both your Wealth Manager and tax planning professional, you can ensure you meet your gifting goals in 2025 while also keeping a watchful eye on the potential tax impact. Just as the mighty redwood sprouts from a small seed, we wish your young one’s money tree grows into wealth, along with their knowledge and responsibility in caring for it.
Sources: IRS, Franchise Tax Board
1 – https://dash.harvard.edu/bitstream/handle/1/11189976/dunn,%20aknin,%20norton_prosocial_cdips.pdf?sequence=1
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