This is a federal income tax concept. Generally, taxable unearned income (interest, dividend, capital gain, and rental income) received by a dependent may be taxed at the parent’s tax rates. This is known as Kiddie Tax.
A dependent is anyone who isn’t required to file their own tax return. The Kiddie Tax rule applies to the following types of dependents:
- Children under age 18 at the end of the tax year
- Adults (age 18) at the end of the tax year who didn’t earn income that was more than half of their support
- Full-time students aged 19 through 23 whose earned income was less than half of their support
In general, there are three incremental tax brackets. The brackets are set annually by tax law and the IRS.
- Bracket #1 – Unearned income that totals up to the annual standard deduction for a dependent is 100% tax free.
- Bracket #2 – Unearned income in excess of the standard deduction, but under the Kiddie Tax threshold, is taxed at the child’s marginal tax rate. Taxability depends on the child’s earned income and deductions.
- Bracket #3 – Unearned income in excess of the annual Kiddie Tax threshold is taxed at the parent’s marginal tax rate.
When harvesting capital gains, particularly for a dependent child, be mindful of the Kiddie Tax brackets. Work with your tax preparer to determine how much capital gain can be realized at 0% tax and whether Kiddie Tax will apply.
For more information on tax-gain harvesting, click here.