What is Kiddie Tax?

B is correct. The kiddie tax taxes unearned income (like dividends) above $2,700 at the parents' marginal tax rate. Currently generating $2,000 annually, they're below the threshold, but as contributions grow and dividend income exceeds $2,700, the excess will be taxed at the parents' rates instead of their daughter's lower rates (for qualified dividends, that means the parents' capital gains rate, such as 15%, rather than their 32% ordinary rate). This significantly reduces the tax-shifting benefit of custodial accounts.

A is incorrect because it ignores the kiddie tax threshold. Only the first $2,700 of unearned income escapes the parents' rate (the first $1,350 is offset by the child's standard deduction and the next $1,350 is taxed at the child's rate); amounts above that are taxed at the parents' rate. C is incorrect because the kiddie tax doesn't limit contributions; it only affects how income above $2,700 is taxed. They can contribute unlimited amounts, but the tax benefit diminishes. D is incorrect because UGMA account income is not tax-free; it's taxable income reported on the child's tax return, subject to kiddie tax rules.

B is correct. For 2026, the kiddie tax applies to unearned income exceeding $2,700. The first $2,700 of a child's unearned income (dividends, interest, capital gains) is not taxed at the parent's rate: for a child with no earned income, the first $1,350 is offset by the child's standard deduction and the next $1,350 is taxed at the child's rate. Any amount above this threshold is taxed at the parent's marginal rate.

A ($1,150) is an outdated or incorrect threshold. C ($2,500) is a common distractor but not the current threshold for kiddie tax. D ($5,000) is not related to kiddie tax thresholds. The $2,700 figure is the critical number to remember for exam questions involving custodial account taxation.

B is correct. Only unearned income is subject to the kiddie tax, so the $3,000 in wages is set aside and taxed at the child's own rate.

Step 1: Identify unearned income: $6,500 of bond interest.

Step 2: Apply the 2026 threshold: net unearned income is the unearned income minus two $1,350 amounts, so the first $2,700 is not taxed at the parents' rate. (Because the child also has wages, the child's own standard deduction is $3,450, the wages plus $450, rather than $1,350.)

Step 3: Unearned income taxed at the parents' rate: $6,500 - $2,700 = $3,800.

Step 4: Tax at the parents' 32% rate: $3,800 × 0.32 = $1,216.

A ($864) applies the parents' 32% rate to the $2,700 threshold ($2,700 × 0.32) instead of to the excess. C ($1,344) applies 32% to $4,200, but $6,500 - $2,700 is $3,800. D ($2,080) applies the 32% rate to all $6,500 of unearned income: $6,500 × 0.32 = $2,080.

C is correct (the exception). Earned income from W-2 wages or self-employment is not subject to the kiddie tax and is always taxed at the child's own tax rate. The kiddie tax applies exclusively to unearned income (dividends, interest, capital gains, rent, royalties). A teenager working a summer job earning $10,000 pays tax at their own lower rate, not the parents' rate.

A is accurate: The kiddie tax specifically targets unearned investment income to prevent income shifting strategies. B is accurate: For a child under 18, no support test applies; the rule reaches unearned income above the threshold as long as a parent is alive at year-end and the child does not file a joint return. D is accurate: The kiddie tax was enacted by Congress specifically to prevent families from transferring assets to children in lower tax brackets to reduce overall family tax liability.

B is correct. Statements 1, 2, and 3 are accurate.

Statement 1 is true: Earned income (W-2 wages) is never subject to the kiddie tax. The $4,500 in wages is taxed entirely at the child's own tax rate, regardless of the parents' income or tax bracket.

Statement 2 is true: The first $2,700 of unearned income (here, bond interest) escapes the parents' rate, because for 2026 net unearned income is figured by subtracting two $1,350 amounts. (Because the child also has wages, the child's own standard deduction is $4,950, the wages plus $450.)

Statement 3 is true: Interest income above the $2,700 threshold is taxed at the parents' marginal rate. The excess is $7,200 - $2,700 = $4,900, which will be taxed at 32% (the parents' rate) instead of the child's lower rate.

Statement 4 is false: Nothing requires the child's income to go on the parents' return. The child files their own return, which uses the parents' marginal rate to compute the kiddie tax. Parents may elect to report a child's income on their own return only when the child's gross income is solely interest and dividends (more than $1,350 and less than $13,500 for 2026), so the election is not available to a child with wages. This is especially important for UGMA/UTMA accounts, which always use the child's SSN.