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Parents and grandparents often take great satisfaction in helping younger family members financially. Whether it’s giving appreciated stock, funding investment accounts, contributing to education savings, or making gifts during your lifetime, generosity can be deeply rewarding. But without careful planning, well-intentioned gifts can create unexpected tax consequences for the very people you’re trying to help.

A recent article in The Wall Street Journal highlighted a tax issue that catches many families by surprise: the “kiddie tax.” The article noted that certain gifts can generate investment income that is taxed at the parents’ higher tax rate rather than the child’s lower rate, resulting in an unexpected tax bill for families.

Understanding the Kiddie Tax

The kiddie tax was created to prevent families from shifting investment income to children in lower tax brackets to reduce taxes. Under current law, the rules generally apply to:

• Children under age 18
• Children under age 19 at year-end whose earned income does not exceed half of their support
• Full-time students ages 19–23 who do not provide more than half of their own support

The affected income includes dividends, interest, capital gains, and distributions from inherited retirement accounts. A child who receives investments generating significant income may end up paying taxes at rates tied to their parents’ income level rather than their own.

The Core Thresholds

Unearned income for children is categorized into three tiers:

1. Up to $1,350: Tax-free, covered by the dependent standard deduction.
2. $1,351 to $2,700: Taxed at the child/grandchild’s marginal tax rate.
3. Over $2,700: Taxed at the parents/grandparents’ marginal tax rate.

Example: 16-Year-Old with Investments

Imagine your 16-year-old dependent receives $5,000 in dividends and capital gains from an UGMA/UTMA custodial account.  Assuming you are in the 32% marginal tax bracket, the income is handled on IRS Form 8615 as follows:

• First $1,350: Tax-free.
• Next $1,350: Taxed at the child’s 10% rate -> $135 tax.
• Remaining $2,300: ($5,000 – $2,700) Taxed at the parents’ 32% rate -> $736 tax.

Total Tax Owed: $869 (versus what would be over a thousand dollars if purely at parental rates).

Lifetime Giving Requires Strategic Planning

This does not mean you should avoid helping your children or grandchildren. In fact, many families are increasingly choosing to transfer wealth during their lifetimes rather than waiting until death. Parents and grandparents often find it meaningful to witness the positive impact their generosity has on future generations.

That said, the manner in which assets are transferred matters significantly. Before making substantial gifts, consider:

• The type of asset being gifted and whether it generates income
• The child’s age and financial circumstances
• Potential capital gains consequences
• Whether other planning vehicles may be more appropriate

Advanced Planning Opportunities

For high-net-worth families, strategic gifting is often part of a broader wealth transfer plan. Depending on your objectives, advanced planning strategies may include:

• Carefully structured annual gifting programs
• Trust planning designed to achieve tax and asset protection goals
• Education savings strategies
• Coordinated planning involving investment, income tax, and estate tax considerations

Thoughtful planning can help families accomplish two important goals simultaneously: providing meaningful financial assistance to loved ones while minimizing unintended tax consequences.

The Bottom Line

Generosity is a wonderful thing. But financial gifts should be made with both your heart and your tax advisor engaged.

A gift that seems simple today can produce complex tax consequences tomorrow. By incorporating advanced planning strategies into your estate plan, you can help ensure that the wealth you transfer benefits your family in the way you intended.

At Botti & Morison’ we work with individuals and families to design sophisticated wealth transfer strategies that seek to preserve assets, reduce unnecessary taxes, and create lasting legacies for future generations.

Thanks for reading.
Chris Michail, Esq.

This blog is for informational purposes only and does not constitute legal advice. Every situation is unique, and you should consult with a qualified attorney for advice regarding your specific circumstances.