A. First of all, what is kiddie tax?
The tax law has long applied special rules to the income of children, recognizing that on the one hand, as with any income, it should be taxed, but on the other hand, the fact that tax brackets start out lower may create incentives for families to shift and split income, especially from passive assets, in order to use (and potentially abuse) those lower tax brackets.
Earned vs. Unearned Income
As a consequence, the tax law has different treatment for earned income of dependent children – from tips and wages, to babysitting and dog-walking and lawn mowing – versus the treatment of unearned income (i.e., interest, dividends, and capital gains).
Kiddie Tax
Generally, earned income of children is taxed at their own (typically low) tax brackets, but unearned income is taxed at the parents’ income (after allowing a $1,050 standard deduction, and another $1,050 to be taxed at the child’s tax rates). However, under the Tax Cuts and Jobs Act, this “kiddie tax” of subjecting a child’s unearned income to his/her parents’ top tax rates has changed, and children’s unearned income is now taxed at the trust tax brackets instead (which can reach the top tax bracket far more quickly due to compressed trust tax brackets!).
Next, we will discuss some tax planning strategies.