Kiddie Tax Rules: IRC Section 1(g) CPA REG Guide
Master the kiddie tax rules under IRC Section 1(g) for the CPA REG exam. Covers which children are affected, the unearned income threshold, computation methods, and TCJA changes.
The Kiddie Tax Under IRC Section 1(g)
The kiddie tax, codified in Section 1(g), is designed to prevent parents from shifting investment income to their children to take advantage of the children's lower tax brackets. Under these rules, a child's unearned income above a threshold amount is taxed at the parents' marginal rate rather than the child's own rate. For CPA REG candidates, the kiddie tax requires understanding which children are subject to the rules, how unearned income is computed, and the two methods available for reporting the income.
Which Children Are Subject to the Kiddie Tax?
Age Requirements
The kiddie tax applies to: children under age 18 at the end of the tax year; children who are age 18 at the end of the tax year and whose earned income does not exceed one-half of their support; and children who are full-time students between ages 19 and 23 at the end of the tax year whose earned income does not exceed one-half of their support. Once a child reaches age 24 (or age 19 if not a full-time student and self-supporting), the kiddie tax no longer applies.
Other Requirements
The kiddie tax applies only if the child has at least one living parent at the close of the tax year and the child does not file a joint return. The child must have unearned income exceeding the threshold amount. If the child's unearned income is below the threshold, the child's income is taxed at the child's own rates regardless of the child's age.
Computing the Kiddie Tax
Unearned Income Threshold
For 2024, the threshold is $2,500 (indexed for inflation). The first $1,250 of unearned income is offset by the child's standard deduction. The next $1,250 is taxed at the child's own rate. Unearned income above $2,500 is taxed at the parents' marginal rate. Unearned income includes interest, dividends, capital gains, rents, royalties, and other investment income. It does not include wages, salaries, or income from self-employment.
Determining the Parents' Rate
Under current law (after the SECURE Act reversed the TCJA's temporary change), the child's unearned income above the threshold is taxed at the parents' marginal rate, not at the estate and trust rates as was briefly the case for 2018-2019. If the parents are married filing jointly, the combined income determines the marginal rate. If the parents are divorced, the custodial parent's rate applies. If the custodial parent has remarried, the stepparent's income is included in determining the rate.
The Allocable Parental Tax
The computation involves adding the child's net unearned income to the parents' taxable income, computing the parents' tax on the combined amount, subtracting the parents' tax on their own income, and allocating the increase to the child. If multiple children are subject to the kiddie tax, the total net unearned income of all such children is combined for the computation, and the resulting additional tax is allocated among the children based on their relative shares of net unearned income.
Two Reporting Methods
Method 1: Child Files Own Return (Form 8615)
The child files a separate tax return and attaches Form 8615 (Tax for Certain Children Who Have Unearned Income). The child's tax is computed using the parents' marginal rate for the net unearned income portion and the child's own rate for earned income and the first $2,500 of unearned income. This method must be used if the child has any earned income or unearned income exceeding $12,500.
Method 2: Parents' Return (Form 8814)
If the child's income consists solely of interest and dividends totaling less than $12,500, the parents may elect to include the child's income on their own return using Form 8814. This eliminates the need for the child to file a separate return. However, this election may increase the parents' AGI, potentially affecting deductions and credits that phase out based on AGI.
Planning Considerations
- Tax-exempt investments: Municipal bond interest is excluded from gross income and avoids the kiddie tax.
- Series EE/I bonds: Interest may be excluded if used for qualified education expenses.
- Earned income: The kiddie tax only applies to unearned income; shifting earned income to children (through legitimate employment) is not affected.
- Roth IRAs: Children with earned income can contribute to Roth IRAs, sheltering future investment income from the kiddie tax.
CPA Exam Tips
- Know the age limits: under 18, age 18 without self-support, full-time students 19-23 without self-support.
- The threshold is $2,500 (2024): first $1,250 offset by standard deduction, next $1,250 at child's rate, excess at parents' rate.
- Current law uses the parents' marginal rate (not trust rates).
- Form 8814 election is available only for interest and dividends under $12,500.
- Only unearned income is subject to the kiddie tax; earned income is taxed at the child's own rate.
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