At this time of year with the start of the fall semester for colleges and universities about a month away, some unwary parents and grandparents may make their children and grandchildren subject to the “kiddie tax”. This column discusses the “kiddie tax”. The “kiddie tax” is an often-overlooked levy that taxes the unearned income of children and grandchildren at the parents’ federal tax rate rather than the child’s lower federal tax rate. The “kiddie tax” could affect children who have unearned income (mostly investment income) exceeding $2,700 during 2026.
The easiest way to understand the “kiddie tax” is through an example. The example is as follows: A grandmother wants to help an 18-year grandchild pay her fall semester 2026 college tuition bill. She gifts the grandchild $50,000 of highly appreciated stock to sell. If the grandmother were to sell the highly appreciated stock, the resulting net long-term capital gain income would be subject to a 23.8 percent federal tax rate (20 percent capital gains preferential tax rate, plus a 3.8 percent net investment income tax, or NIIT). But grandma is gifting the stock to her grandchild because grandma assumes her grandchild will not owe capital gains tax on the stock sale due to the fact that the grandchild is in a zero percent federal capital gains tax bracket.
Grandma is unfortunately mistaken. Since her grandchild is 18 years old and a full-time student, the grandchild is subject to the “kiddie tax” and will owe tax on the appreciated stock sale calculated based on her grandchild parents’ federal tax rate. That tax rate is 18.8 percent, consisting of the 15 percent federal capital gains preferential tax rate (typical for an upper middle-income married couple) plus a 3.8 percent NIIT. If, for example, the net capital gain resulting from the stock sale is $50,000 (sales price) minus $20,000 (stock’s cost basis) or $30,000, then the tax due on the sale would be 18.8 percent times $30,000 equals $5,640. The $5,640 federal income tax due is far greater than the $0 that grandma expected.
History of the Federal “Kiddie Tax”
The “kiddie tax” was passed into law in 1986 as part of the Tax Reform Act of 1986. Congress enacted the “kiddie tax” in order to prevent wealthy Americans from shifting investment income to their lower taxed children and grandchildren. When first enacted, the “kiddie tax” applied to children under the age of 14. Over the years, the “kiddie tax” was broadened in several ways. First, the “kiddie tax” can apply to young adults below the age of 24.
The “kiddie tax” also applies to a wide range of unearned income including investment income – interest, dividends and capital gains, payouts from inherited IRAs and most recently, Trump Account distributions (see below). The “kiddie tax” does not apply to “earned income” (wage/salary income). That is good news if a teenager or college student is working over the summer, such as a lifeguard or a camp counselor. The teenager’s 2026 salary income is not subject to the “kiddie tax”.
The newest addition to a “kiddie tax” pitfall is the Trump Account, the tax-deferred savings vehicle for children under age 18 that began July 5, 2026. Children born between January 1,2025 and December 31,2028 will get a $1,000 contribution to their Trump Account from the federal government. Parents and others can contribute a total of $5,000 more each year to a child’s Trump account until the child becomes 18. Once the child becomes aged 18, the account can be converted to a Roth IRA. However, the “kiddie tax” could be triggered on some or all of the converted amount if the child is age 19 through 23 and a full-time student. For that reason, any Trump Account owner who wants to eventually convert their Trump Account to a Roth IRA is advised to wait until they are age 24 when the “kiddie tax” no longer applies.
No doubt that the “kiddie tax” is complex. The following is a discussion of the key features of the “kiddie tax”. For additional information, IRS Tax Topic 553 (Tax on a Child’s Investment and Other Unearned Income Kiddie Tax) (www.irs.gov/taxtopics/tc553) provides additional information and details.
Which Children Are Subject to the “Kiddie Tax”?
The “kiddie tax” applies to a child (or more than one child in a family) when all of the following conditions are met during the tax year: (1) The child does not file a joint tax return for the year; (2) One or both of the child’s parents are alive at the end of the year; (3) The child’s net unearned income for the year exceed the threshold for that year and the child has taxable income after subtracting any applicable deductions such as the standard deduction; and (4) The child falls into one of three age rules summarized in the following table:
Children Subject to the Kiddie Tax Rules1
|
Age at Year-End |
Rules Apply If…. |
|
<18 |
Always apply |
|
18 |
Child’s earned income ≤ 50 percent of child’s support2 |
|
19-23 |
Child is a full-time student and earned income is ≤ 50 percent of child’s support3 |
|
> 23 |
Never apply |
1 Exception: The “kiddie tax” rules do not apply if the child is married and files a joint tax return or does not have at least one living parent at year-end.
2 For 2026, the age of a child with a January 1st birthday is determined as of January 1, 2027.
3 Support includes amounts spent on the child’s food, lodging, clothing, education, medical and dental care, recreation, transportation and similar necessities.. A scholarship a child receives is not considered if the child is a full-time student
Which Income Is Subject to the “Kiddie Tax”?
Total income consists of earned income plus unearned income. Therefore.
Unearned income = Total Income – Earned Income
The “kiddie tax” is calculated using a child’s unearned income. Unearned income includes taxable interest, dividend and capital gain investment income , the taxable part of Social Security and pension payments, certain distributions from trusts, unemployment compensation and inherited IRAs.
What is the “Kiddie Tax” Threshold for 2026?
A child’s total unearned income for 2026 is subject to the “kiddie tax” above an annual threshold equal to $2,700 for 2026. The $2,700 threshold comprises two halves: (1) $1,350 of unearned income which is tax-free and (2) $1,350 is taxed at the child’s marginal tax bracket. Often that tax bracket is 10 percent for ordinary income and zero percent for long-term capital gains and certain dividends.
Above the $2,700 threshold, the unearned income is taxed at the parents’ top marginal tax rate for the year.
Options for Filing Tax Returns Subject to the “Kiddie Tax”
Interaction of the “Kiddie Tax” with the Federal Gift Tax Exemption
As discussed, the “kiddie tax” applies only to a range of unearned income. That means if someone – a parent, grandparent or other relative – gifts in cash or assets to a child up to $19,000 during calendar year 2026 – that transfer is federal gift tax free and will not incur a “kiddie tax”. Nor does a gift of less than $19,000 during 2026 reduce the gift donor’s lifetime gift exemption (which during 2026 is $15 million per individual). Note that some “kiddie tax” could be owed if a gift produces taxable income. For example, a gift of stock that produces taxable dividends or capital gain income resulting from the sale of the appreciated stock could result in taxable income for the gift recipient.
Federal employees and retirees who are thinking about gifting assets to their children or grandchildren in order to assist them pay for college this fall are advised to first consult with a tax professional to discuss any possible “kiddie tax” and gift tax consequences.
A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement! Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over 20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.
He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters, and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
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