The Kiddie Tax and Family Income Shifting: What Still Works
Putting investments in a child's name used to be a simple way to have income taxed at a lower rate. The kiddie tax closed most of that door, but several approaches remain useful.
Parents in high brackets have an obvious incentive to move income to children in low brackets. A Bay Area couple paying 37% federal and 12.3% California on their marginal dollar might wonder whether a custodial account in a child's name could hold the family's dividend-paying stocks. The kiddie tax exists to limit that strategy, and it reaches further than many parents expect.
Who the kiddie tax covers
According to IRS Topic 553, the rules apply to children under 18 at year-end, children who are 18 and whose earned income does not exceed half their support, and full-time students aged 19 through 23 who likewise do not support themselves through earned income. A 21-year-old college student living on parental support and investment income is covered; a 19-year-old working full time is not. At least one parent must be alive at year-end.
For 2026, the IRS sets the relevant amount at $1,350. In practice that means a covered child's first $1,350 of unearned income is offset by the child's standard deduction, the next $1,350 is taxed at the child's own rate, and unearned income above $2,700 is taxed at the parents' marginal rates. Unearned income includes interest, dividends, capital gains, and distributions from trusts. Earned income from a job is taxed at the child's own rates regardless. The tax is computed on Form 8615, and parents whose child's income consists only of interest and dividends and is less than $13,500 may elect on Form 8814 to report it on their own return, which is simpler but can raise the parents' AGI.
What this means for custodial accounts
A UTMA or UGMA account funded with $50,000 of stock producing $2,000 of dividends a year will generate a small tax at the child's rates. Push that to $200,000 with $8,000 of dividends and most of the income is taxed as though the parents earned it. Custodial accounts also have non-tax drawbacks: the assets belong irrevocably to the child, who gains full control at the age set by state law, and they weigh against need-based financial aid. The kiddie tax removes much of the reason to accept those drawbacks for investment income.
Approaches that still work
Several strategies shift wealth or income to children without running into the kiddie tax.
Contributions to a 529 plan grow tax-deferred and come out tax-free for qualified education expenses, so there is no unearned income to tax at all. The 2026 annual gift exclusion of $19,000 per donor per recipient applies, and a five-year election allows a larger front-loaded gift. Beginning in 2026, 529 withdrawals for K-12 tuition are limited to $20,000 per year. The trade-off is that non-qualified withdrawals face tax and a penalty on earnings.
The new Trump accounts, seeded with $1,000 for children born from 2025 through 2028 and allowing $5,000 in annual contributions, offer tax-deferred growth, with rules on distributions still being clarified.
A child with genuine earned income, whether from a summer job or a legitimate role in a family business, can contribute up to the lesser of that income or the 2026 IRA limit of $7,500 to a Roth IRA. Earned income is not subject to the kiddie tax, and decades of tax-free growth can be substantial. Wages paid to a child must be reasonable for real work and properly documented.
Gifting appreciated stock to a child who is beyond kiddie tax age, such as a working 24-year-old, allows the child to sell at their own capital gains rate, which for 2026 is 0% for single filers with taxable income up to $49,450. The gift must be complete, with the child able to use the proceeds as they choose.
Limits and cautions
Income shifting is a modest tool, not a transformative one. The annual exclusion caps what can be moved without using lifetime exemption, and the $15 million lifetime exemption is generally better reserved for estate planning than for saving a few thousand dollars of income tax. California has no separate kiddie tax but taxes a child's income at its own rates, and a child with more than a small amount of income may need to file a state return. Above all, money given to a child is the child's, and a plan that depends on a 19-year-old making prudent choices carries its own risk.
This article is educational only and is not tax, legal, or investment advice. Family gifting and account decisions depend on individual circumstances, and readers should consult a qualified tax or legal professional.
Important Disclosures
Important Disclosures: Propulsion Capital Management is an investment adviser registered with the State of California Department of Financial Protection and Innovation. Registration does not imply a certain level of skill or training. This article is provided for general informational and educational purposes only and does not constitute investment, tax, legal, or accounting advice, nor an offer or solicitation to buy or sell any security or to adopt any particular investment strategy. The information is believed to be accurate as of the date of publication but is subject to change without notice; tax laws and regulations change frequently and their application depends on individual facts and circumstances. Nothing herein should be relied upon as a substitute for personalized advice from a qualified professional. Investing involves risk, including the possible loss of principal, and past performance is no guarantee of future results. Diversification does not ensure a profit or protect against loss. Any examples are hypothetical, are for illustrative purposes only, and do not reflect the experience of any client. Links to third-party websites are provided for convenience; Propulsion Capital Management does not endorse, and is not responsible for, the content of third-party sites. Propulsion Capital Management does not provide tax or legal advice; please consult your tax adviser or attorney regarding your specific situation.
