The Kiddie Tax, Custodial Accounts, and Investing for Kids

Parents and grandparents who want to invest for a child usually hear two pieces of advice that conflict. The first is to put money in the child's name so it grows at the child's low tax rate. The second is to watch out for the kiddie tax, which sends most of that income right back to the parents' rate. Both are true, and the space between them is where good planning happens.

The kiddie tax exists precisely because shifting investment income to children used to be an easy way for high earners to cut their tax bill. Congress closed that door in 1986 and has adjusted it several times since. What remains is a modest allowance of income that can be taxed at the child's rate, plus several account types that avoid the issue entirely. This guide explains how the kiddie tax works for 2026, how custodial accounts are taxed and controlled, and how to build an investing plan for a child that does not waste the allowance. It is educational, not individualized advice.

How the Kiddie Tax Works

The kiddie tax applies to a child's unearned income: interest, dividends, capital gains, and distributions from trusts and custodial accounts. Earned income from a job is never subject to it. For 2026, the structure has three layers. The first roughly $1,350 of unearned income is covered by the child's standard deduction and is tax-free. The next roughly $1,350 is taxed at the child's own rate, which is 10 percent for ordinary income and 0 percent for long-term gains and qualified dividends. Everything above about $2,700 is taxed at the parents' marginal rate, as if the parents had earned it. The IRS adjusts these thresholds annually and explains the rules in Topic 553.

For a physician or executive family in the 35 or 37 percent bracket, a custodial account throwing off $10,000 of dividends produces roughly the same tax as if the parents held the money themselves.

A parent's rate applies even if the parents do not claim the child as a dependent, and it uses the rate of the parent with the higher income if they file separately. The calculation is done on Form 8615, which is attached to the child's own return.

Which children are covered

The kiddie tax applies to any child under 18 at year-end with more than the threshold of unearned income. It also applies to 18-year-olds whose earned income does not exceed half of their own support, and to full-time students aged 19 through 23 in the same situation. A 22-year-old college student with a custodial account funded by grandparents is typically still subject to it. A 19-year-old working full time and paying most of her own expenses is not. Once the child ages out, the income is taxed at the child's own rate, which is where the 0 percent capital gains rate becomes useful.

Filing options: the child's return or the parents' return

If a child's only income is interest, dividends, and capital gain distributions, and it falls under a cap of ten times the base threshold, parents can elect to report it on their own return using Form 8814 instead of filing a separate return for the child. It is simpler, but it can cost more, because the income increases the parents' adjusted gross income and can reduce other deductions and credits. Filing a separate return for the child with Form 8615 is usually the better choice for higher earners, and it is required if the child sold securities during the year.

Custodial Accounts: How UTMA Accounts Are Taxed and Controlled

A custodial account under the Uniform Transfers to Minors Act is the simplest way to hold investments for a child. An adult custodian manages the account, but the child is the legal owner from day one. Contributions are irrevocable gifts. They count against the annual gift tax exclusion, which is $19,000 per donor per child for 2026, so two parents can give $38,000 to each child without filing a gift tax return.

The account is taxed to the child, which is exactly what triggers the kiddie tax. Interest and dividends flow through each year, and sales inside the account generate gains or losses on the child's return. The custodian must use the money for the child's benefit and cannot take it back, reassign it to a sibling, or use it for ordinary parental support obligations such as food and housing.

Control ends at the age set by state law. In Georgia, the child takes full ownership at 21. At that point a 21-year-old can spend the account on anything. Families who are uncomfortable with that outcome usually keep custodial accounts modest and put larger sums in accounts that the parents continue to control, or in trusts drafted by an estate planning attorney.

Financial aid and other drawbacks

Custodial accounts count as the student's asset on the federal financial aid form, and student assets are assessed at a much higher rate than parental assets. For families who expect need-based aid, that is a real cost. High-income families who do not expect aid can ignore it. Custodial accounts also do not shift assets out of the estate of a grandparent who names himself custodian, so grandparents should name a parent as custodian instead.

Investing a Custodial Account Around the Kiddie Tax

Because the kiddie tax only bites above the threshold, the goal is to keep the child's annual unearned income near it, not far above it. That is a portfolio design question.

• Favor broad growth-oriented index funds with low dividend yields over bond funds, high-dividend stocks, or REITs. A fund yielding 1.2 percent can hold well over $200,000 before dividends alone reach the threshold.
• Avoid actively managed mutual funds that distribute large capital gains each December, which you cannot control.
• Harvest gains deliberately each year. Sell enough appreciated shares to bring total unearned income to just under the threshold, then buy them back. Long-term gains in that band are taxed at 0 percent, and the basis steps up permanently. Over a childhood, this can wipe out most of the embedded gain in the account.
• Hold cash and bonds in the parents' names or in a tax-advantaged account rather than in the custodial account, where interest is taxed at ordinary rates once the threshold is crossed.
• Keep records of every contribution and sale. Brokers track basis for covered shares, but custodial accounts often move between institutions when the child comes of age.

Better Accounts for Some Goals

A custodial account is one option among several, and the alternatives avoid the kiddie tax in different ways.

Roth IRA for a child with earned income

A child who earns money from a job, including legitimate work in a family business, can contribute to a Roth IRA up to the lesser of their earnings or the annual IRA limit. Parents can fund the contribution as a gift as long as the child had at least that much earned income. The account grows tax-free, is never subject to the kiddie tax, and does not count on the federal aid form. Contributions can be withdrawn at any time without tax, which makes it far more flexible than most people assume.

Education accounts

A 529 plan grows tax-free when used for qualified education expenses, is controlled by the parent, and is not subject to the kiddie tax because no income is reported until a withdrawal. It is the right tool for money that is genuinely earmarked for education. It is not the right tool for every family or every dollar, since non-qualified withdrawals face tax and a penalty on earnings, and funding it should come after retirement savings and alongside your estate plan. Our article on 529 plans for college investing weighs those trade-offs.

New child savings accounts

The 2025 tax law created a new tax-advantaged savings account for children under 18, with annual contribution limits and a one-time federal contribution for children born in certain years. Contributions are expected to open in mid-2026 and the money grows tax-deferred, with withdrawals taxed under rules similar to a traditional IRA. Details are still being finalized by Treasury, so treat this as a supplement to review once the accounts are live rather than a replacement for the options above.

Gifts of appreciated stock

Giving appreciated shares to a child carries your cost basis to them. If the child is subject to the kiddie tax, selling produces a gain taxed at your rate, so there is no benefit. Once the child is past the kiddie tax years and in a low bracket, the same gift can be sold at 0 percent. Timing the gift to the child's age is the whole strategy, and our overview of tax-smart gifting to family explains the mechanics.

A Practical Plan for High-Income Families

Most families we work with land on a layered approach rather than a single account.

• Fund retirement accounts first. A child's future is better served by parents who do not need support later.
• Use a 529 for money clearly intended for education, sized to a realistic estimate of costs and your own comfort with the restrictions.
• Open a Roth IRA for any child with real earned income and fund it up to their earnings.
• Use a custodial account for a modest amount you are comfortable handing over at 21, invested in low-dividend growth funds, and harvest gains up to the kiddie tax threshold each year.
• Keep larger sums intended for a child in your own name or in a trust prepared by your estate attorney, where you retain control and the tax treatment is predictable.
• Revisit the mix each year as the child's age, earned income, and the thresholds change.

The kiddie tax is not a reason to avoid investing for children. It is a boundary. Inside it, a custodial account can grow with almost no tax, gains can be harvested at 0 percent, and a child can learn to manage real money. Outside it, the tax advantage disappears and the question becomes one of control and purpose rather than rates. Families who understand where that line sits tend to use each account for what it does best, which is the approach our financial planning service takes when helping families organize savings for the next generation.

Tony Colunga · Founder, Attend Wealth

Tony leads Attend Wealth, a fee-based wealth management firm in Atlanta serving professionals, families, physicians, and business owners. Advisory services are held to a fiduciary standard. More about Attend