The Kiddie Tax Trap: What High-Earning Parents Need to Know Before Shifting Income to Children

Opening a Uniform Gifts to Minors Act (UGMA) account for your child and buying dividend-paying stocks inside it feels like a smart move. The assumption is that the income gets taxed at the kid's lower rate. For most high-earning families with children under 24, the kiddie tax changes that.

The kiddie tax, codified under Internal Revenue Code (IRC) §1(g), exists to close that door. Congress designed it to prevent parents from parking investment assets in a child's name to access lower brackets. Unearned income above a modest annual threshold is taxed at the parent's marginal rate.

How the Threshold Works in Practice

For 2026, the first $1,350 of a child's unearned income is tax-free, and the next $1,350 is taxed at the child's own rate. Everything above $2,700 is taxed at the parent's marginal rate.

Consider a hypothetical client whose 16-year-old holds a UGMA account generating $8,000 in qualified dividends in 2026. The parent is in the 37% federal bracket.

• $1,350: no tax
• $1,350: taxed at the child's rate (likely 0% on qualified dividends)
• Remaining $5,300: taxed at the parent's rate (for qualified dividends, the parent's 20% long-term capital gains rate)

The account is in the child's name, but most of the income is taxed at the parent's rate.

Which Income Is Caught and Which Isn't

Unearned income subject to the kiddie tax includes dividends, interest, capital gains distributions, and other investment income earned inside UGMA or Uniform Transfers to Minors Act (UTMA) accounts. Earned income from a real job the child works is not subject to the kiddie tax.

529 distributions used for qualified education expenses are not taxable at all, which is why 529s remain a clean vehicle for college savings regardless of a parent's bracket. The kiddie tax issue is specific to taxable custodial accounts generating investment income.

When Income-Shifting Works

The kiddie tax applies to children under 19, and extends through age 23 for full-time students whose earned income doesn't exceed half of their own support. Once a child is no longer a full-time student, or turns 24, the kiddie tax falls away. At that point, gifting appreciated securities or income-producing assets becomes a legitimate planning lever.

The mistake I see most often is a wrong assumption about timing. Parents fund UGMAs when children are young, expecting lower tax rates for years. They get the parent's rate for most of that window and, eventually, an irrevocable account the child controls completely at the age state law sets, typically 18 or 21 (up to 25 in some states, including California).

The Takeaway

The child's age and student status decide whether income-shifting makes sense and which vehicle to use. Done in the wrong account at the wrong stage of a child's life, it costs more in taxes than it saves. This detail belongs in the tax side of a plan, where the structure is set before the assets move.

If your family is in a high bracket and you're planning around education funding or generational transfer, the time to review the structure is before the assets go into a custodial account.

The information provided is for educational purposes only and does not constitute investment, legal, or tax advice. Consult with qualified professionals for guidance specific to your situation.