Kiddie Tax Explained
- Kirk Reagan
- Feb 11
- 3 min read
Updated: Feb 12
UTMA Accounts and the Nature of Irrevocable Gifts
Uniform Transfers to Minors Act accounts allow adults to transfer assets into a custodial structure for a child. These accounts exist because minors cannot independently enter binding brokerage contracts. The custodian manages the account until the child reaches adulthood under state law.
Two characteristics define UTMA accounts. First, assets legally belong to the child once transferred. Second, contributions are irrevocable. While funds can be used for the child’s benefit, they cannot be reclaimed for personal use by the custodian. Because the account is under the child’s Social Security number, income generated within it is taxable to the child. That structure is precisely where the kiddie tax becomes relevant.
Why the Kiddie Tax Exists
The kiddie tax was enacted to prevent income shifting from high-income parents to low-income children. Without it, parents could transfer appreciated assets to children, have the children realize gains at low or zero tax rates, and effectively recycle the proceeds back into family wealth. Under kiddie tax rules, once a child’s unearned income exceeds certain thresholds, the excess is taxed at the parent’s marginal rate rather than the child’s rate. Unearned income includes interest, dividends, and capital gains. The result is not a prohibition on gifting assets. It is a limitation on the tax arbitrage that would otherwise occur.
Capital Gain Harvesting Within Thresholds
Despite the kiddie tax, legitimate planning opportunities remain. One such strategy is capital gain harvesting within the allowable income bands. If a child’s total unearned income remains below the applicable threshold, gains can be realized at favorable rates. Selling appreciated securities up to that threshold and repurchasing them resets cost basis without triggering wash sale restrictions, which apply only to losses.
Over time, periodically harvesting gains can raise the child’s cost basis, reducing future taxable gains when the child later sells the assets as an adult with higher earned income.
However, this strategy requires careful monitoring of all unearned income, including dividends and mutual fund distributions. Exceeding the threshold inadvertently can result in part of the income being taxed at the parent’s rate.
Age of Majority and Control Considerations
UTMA accounts eventually transfer control to the child at the age of majority or termination, depending on state law. At that point, the child gains full authority over the assets. Parents cannot revoke the gift or impose new conditions.
This reality introduces a non-tax consideration. Families must be comfortable with the possibility that the child may make independent financial decisions at a relatively young age.
There is also a timing nuance. Even after reaching adulthood, a child may still be subject to kiddie tax rules if they remain a dependent under certain age and support tests. Tax independence does not always coincide precisely with legal adulthood.
A Framework for Thoughtful Use
UTMA accounts can be effective tools when used deliberately. They allow parents to transfer wealth, invest for long-term growth, and potentially manage tax exposure through structured harvesting strategies.
However, they are not informal savings accounts. They create legal ownership, tax reporting obligations, and eventual control transitions. Families should evaluate both the tax and behavioral implications before funding them heavily.
Planning within the rules is more sustainable than attempting to circumvent them. When thresholds are respected and timelines are understood, UTMA accounts and kiddie tax planning can support long-term financial goals without unintended consequences.
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