Question: I’ve heard of Kiddie tax but I’m not sure what it is. Why do children have to pay taxes at a rate higher than their tax bracket?
Answer: A child generally computes their federal income tax liability the same as any other individuals except for certain limits on the standard deduction. However, if the child’s investment income exceeds a threshold amount ($2,200 for 2020 and 2021), then they will be subject to kiddie tax on their net unearned income. (Unearned income includes all income other than wages or payments received for work. Examples of unearned income include interest, dividends, capital gains and IRA distributions.)
Kiddie tax was designed to deter parents from transferring investments into the child’s name to take advantage of their lower tax bracket. Instead, the unearned income in excess of the threshold is taxed at the parent’s marginal tax rate. If the child only has interest and dividend income, a parent may elect to report the child’s income on their own return. If the parent makes this election, the child is not required to file a return.