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 their 32% rate instead of their daughter's lower 10-12% 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 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 taxed at the child's rate, and 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A ($1,150) is an outdated or incorrect threshold.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. Calculate the kiddie tax on unearned income only:

Step 1: Identify unearned income: $6,500 in dividends (the $3,000 W-2 wages are earned income, not subject to kiddie tax).

Step 2: Apply kiddie tax threshold:
- First $2,700 of unearned income: taxed at child's 10% rate = $2,700 × 0.10 = $230
- Remaining unearned income: $6,500 - $2,700 = $4,200, taxed at parents' 32% rate = $4,200 × 0.32 = $1,344

Step 3: Total tax on unearned income: $230 + $1,344 = $1,574

Note: The $3,000 in wages is taxed separately at the child's rate and is not subject to kiddie tax.

A ($230) only calculates tax on the first $2,700 at the child's rate, ignoring the excess taxed at the parent's rate. C is a duplicate of the correct answer. D ($2,080) incorrectly applies the 32% rate to all $6,500 of unearned income: $6,500 × 0.32 = $2,080.

C is correct (the EXCEPT answer). 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: Children under 18 are automatically subject to kiddie tax rules on unearned income; there's no exception for minors under 18. 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 (dividends) is taxed at the child's rate. This is the kiddie tax threshold for 2026.

Statement 3 is TRUE: Dividend 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: The child must file their own tax return using their own Social Security Number. While the kiddie tax uses the parents' marginal rate for calculation purposes, all income is reported on the child's return, not the parents'. This is especially important for UGMA/UTMA accounts, which always use the child's SSN.