Tax Filing Requirements For Minor Children with Investment Income
When parents gift money to their kids, instead of having the money sit in a savings account, often parents will set up a UTMA Account at an investment firm to generate investment returns that can be used by the child at a future date. But if the child is a minor, which is often the case, we have to educate our clients on the following topics:
How UTMA accounts work for minor children
Since the child will have investment income, do they need to file a tax return?
The special standard deduction for dependents
How kiddie tax works (taxed investment income at the parent’s tax rate)
Completed gifts for estate planning
How UTMA Accounts Work
When a parent sets up an investment account for their child, if the child is a minor, they typically set up the accounts as UTMA accounts, which stands for Uniform Transfer to Minors Act. UTMA accounts are established in the social security number of the child, and the parent is typically listed on the account as the “custodian”. As the custodian, the parent has full control over the account until the child reaches the “age of majority”. Once the child reaches the age of majority, the UTMA designation is removed, the account is re-registered into the name of the adult child, and the child now has full control over the account.
Age of Majority Varies State by State for UTMA
While the age of majority varies state by state, the age of majority for UTMA purposes and the age of majority for all other reasons often varies. For most states, the “age of majority” is 18 but the “UTMA age of majority” is 21. That is true for our state: New York. If a parent establishes an UTMA account in New York, the parent has control over the account until the child reaches age 21, then the control of the account must be turned over to their child.
$18,000 Gifting Exclusion Amount
When a parent deposits money to a UTMA account, in the eyes of the IRS, the parent has completed a gift. Even though the parent has control of the minor child’s UTMA account, from that point forward, the assets in the account belong to the child. Parents with larger estates will sometimes include gifting to the kids each year in their estate planning strategy. Each parent can make a gift of $18,000 (2024 Limit) each year ($36K combined) into the child’s UTMA account, and that gift will not count against the parent’s lifetime Federal and State lifetime estate tax exclusion amount.
A parent can contribute more than $18,000 per year to the child’s UTMA account, but a gift tax return may need to be filed in that year. For more information on this topic, see our video:
Video: When You Make Cash Gifts To Your Children, Who Pays The Tax?
When Does The Minor Child Need To File A Tax Return?
For minor children that have investment income from a UTMA account, if they are claimed as a dependent on their parent’s tax return, they will need to file a tax return if their investment income is above $1,250, which is the standard deduction amount for dependents with unearned income in 2024.
For dependent children with investment income over the $1,250 threshold, the investment is taxed at different rates. Here is a quick breakdown of how it works:
$0 - $1,250: Covered by standard deduction. No tax due
1,250 - $2,500: Taxed at the CHILD’s marginal tax rate
$2,500+: Taxed at the PARENT’s marginal tax rate (“Kiddie tax”)
How Does Kiddie Tax Work?
Kiddie tax is a way for the IRS to prevent parents in high-income tax brackets from gifting assets to their kids in an effort to shift the investment income into their child’s lower tax bracket. For children that have unearned income above $2,500, that income is now taxed as if it was earned by the parent, not the child. This applies to dependent children under the age of 18 at the end of the tax year or full-time students younger than 24.
IRS Form 8615 needs to be filed with the child’s tax return, which calculates tax liability on the unearned income above $2,500 based on the parent's tax rate. A tax note here: in these cases, the parent’s tax return has to be completed before the child can file their tax return since the parent’s taxable income is included in the Kiddie tax calculation. In other words, if the parents put their tax return on extension, the child’s tax return will also need to be put on extension.
Unearned vs Earned Income
This article has focused on the unearned income of a child; if the child also has earned income from employment, there are different tax filing rules. The earned income portion of the child’s income can potentially be sheltered by the $14,600 (2024) standard deduction awarded to individual tax filers.
This topic is fully covered in our article: At What Age Does A Child Have To File A Tax Return?
Investment Strategy for Minor Child’s UTMA
Knowing the potential tax implications associated with the UTMA account for your child, there is usually a desire to avoid the Kiddie tax as much as possible. This can often drive the investment strategy within the UTMA account to focus on investment holdings that do not produce a lot of dividends or interest income. It’s also common to try to avoid short-term capital gains within a child’s UTMA account since a large short-term capital gain could be taxed as ordinary income at the parent’s tax rate.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
