Kiddie Tax Rules: Funding Your Kids' Investment Accounts

How to choose the right account before the tax tail starts wagging the plan

August 22, 2026

Helping a child start investing is one of those planning ideas that sounds simple until the details show up. A parent or grandparent can fund an account. The child may have decades for compounding. The account can become a practical way to teach ownership, markets, taxes, and patience.

The tension is that "the child's account" is not always taxed like an adult's account. For 2026, a child's unearned income can run into the kiddie tax once it exceeds $2,700, and the portion above that threshold may be taxed at the parent's rate when the Form 8615 rules apply.^1,2 That does not make taxable custodial accounts bad. It does mean the account should be funded with a clear purpose, a good asset-location decision, and a realistic view of who will control the money later.

What The Kiddie Tax Is Really Trying To Do

The kiddie tax is aimed at a specific behavior: shifting investment income from a high-tax parent to a lower-tax child. The rule does not tax every dollar of a child's investment income at the parent's rate. Instead, it applies to a defined slice of unearned income when the child meets the age, support, filing, and parent-living tests.²

For 2026, the IRS inflation guidance sets the key reduction amount at $1,350. That same amount is tied to the dependent standard deduction for a child with no earned income, and the parent election rules use ten times that amount as a separate gross-income limit.^1,3 In plain English, a child with only ordinary unearned income gets a small federal runway before the parent's marginal rate becomes relevant.

Figure 1 shows the basic federal layering for a simple 2026 illustration: a child has $5,000 of ordinary unearned income, no earned income, no itemized deductions, and a parent in the 24% ordinary income bracket. The first $1,350 is sheltered by the dependent standard deduction, the next $1,350 is taxed at the child's rate in this simplified case, and the remaining $2,300 is exposed to the parent's rate under the kiddie-tax framework.^1,2,3

This is not a tax-return calculation for every family. Qualified dividends, long-term capital gains, capital losses, multiple children subject to Form 8615, state taxes, the net investment income tax, and the parents' actual taxable income can change the answer.² But the chart captures the planning point: once investment income grows past the threshold, the parent rate can become the relevant rate even though the asset is legally the child's property.

The Account Type Matters More Than The Account Label

Most families are really choosing among three buckets.

A taxable custodial account, often opened under a state's UTMA or UGMA law, is flexible. It can hold a broad range of investments. It can be used for more than college. It can also create current taxable income for the child, and the assets generally become the child's property under the applicable minor-transfer law.⁴ That ownership point is not a footnote. Once the child reaches the age of control under state law, the funds are not the parent's asset to redirect.

A 529 plan is more purpose-built. IRS guidance describes qualified tuition programs as accounts established for qualified education expenses, with earnings that can accumulate tax free and distributions that are generally not taxable when used for qualified education expenses.⁵ The tradeoff is flexibility. If the funds are not used for qualified expenses, the tax treatment is less favorable. There are also rules around eligible expenses, state-plan limits, and coordination with tax credits. Recent law has added a limited path for certain long-standing 529 balances to move to a beneficiary's Roth IRA, but that path has conditions: direct trustee-to-trustee transfer, an account open for more than 15 years, annual Roth IRA contribution limits, and a $35,000 lifetime cap.^5,6

A Roth IRA for a child is different again. It requires taxable compensation, so it is usually relevant only once the child has wages, self-employment income, or another form of qualifying compensation.⁶ The long-term tax treatment can be powerful because Roth IRA contributions are not deductible, but qualified distributions can be tax free if the rules are satisfied.⁶ A Roth IRA should not be treated as a workaround for gifting investment income to a child who has no earned income. The contribution has to be supported by compensation and documented cleanly.

Funding The Account Without Creating A Tax Surprise

For 2026, the federal gift-tax annual exclusion is $19,000 per recipient for gifts of present interests.⁷ A married couple may be able to fund more by using both spouses' exclusions, but the legal and reporting details matter, especially if the contribution is not a simple present-interest gift or if larger estate-planning transfers are involved.

The gift-tax rule and the income-tax rule are separate. A contribution may fit within the annual exclusion and still produce taxable income in the child's account later. That is why I would not start with the question, "How much can we put in?" I would start with, "What is this money supposed to do, who should control it, and what type of tax character will the account produce?"

For a taxable custodial account, the asset mix matters. A high-turnover or income-heavy portfolio can use up the child's small runway quickly. A more tax-aware portfolio may reduce annual unearned income, though it may still create capital gains when investments are sold. For a 529 plan, the tax benefit is strongest when the education purpose is real and the family can tolerate the account's restrictions. For a child with legitimate earned income, a Roth IRA may be attractive, but the contribution should never exceed the child's allowable limit and compensation support.

When A Custodial Account Still Makes Sense

The kiddie tax should not scare families away from every custodial account. There are good reasons to use one.

It may make sense when the goal is broad-based wealth education rather than college-only funding. It may fit when parents want the child to own a modest investment account and learn how dividends, interest, gains, losses, and tax forms work. It can also fit when the account is expected to stay relatively small, when the assets are managed tax-efficiently, or when the family intentionally accepts the future control transfer.

It is a weaker fit when the parent is uncomfortable with the child gaining control at the applicable age, when the assets might hurt future financial-aid positioning, when the likely investments will throw off meaningful annual income, or when the money is really earmarked for education and a 529 plan would give better tax treatment. It can also be a poor fit when parents are trying to solve an estate or income-tax problem without coordinating the legal ownership, gift-tax, and income-tax pieces.

The Parent Election Is A Convenience, Not Always A Savings Tool

The IRS allows a parent in some cases to report a child's interest, ordinary dividends, and capital gain distributions on the parent's return instead of filing a separate return for the child. For 2026, one requirement is that the child's gross income be more than $1,350 and less than $13,500; the child must also meet the other age, income-type, withholding, estimated-payment, return-filing, and parent-eligibility requirements.^1,2

That election can simplify filing. It does not automatically lower the tax. In some cases, the IRS itself notes that tax may be higher if the election is made rather than filing the child's own return with Form 8615.⁸ The cleaner planning habit is to decide in advance how the account will be invested and how tax documents will be handled, then let the CPA compare the actual filing options when the numbers are known.

The Takeaway

The best account for a child is not the one with the catchiest label. It is the one that matches the purpose of the money.

If the purpose is education, start by evaluating the 529 plan. If the purpose is early retirement compounding and the child has legitimate taxable compensation, look closely at the Roth IRA rules. If the purpose is flexible investing, financial education, or a broader gift, a custodial taxable account can work, but go in with open eyes: the child owns the property, investment income belongs on the child's tax map, and the kiddie tax can pull some of that income back to the parent's rate.

What does this mean for your plan? Before funding the account, we would coordinate the account type, investment strategy, expected income, gift size, and future control with your CPA and, when legal ownership or larger transfers are involved, your attorney. The account should teach good stewardship. It should not create a tax surprise that could have been avoided with a few decisions upfront.

Used thoughtfully, a child's investment account can be more than a balance on a statement. It can be a training ground for wise decisions. The planning work is making sure the tax rules, account structure, and family intent all point in the same direction.

All my best, 

Brandon VanLandingham, CFA, CMT, CFP 

Founder / CIO

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Citations

1. Internal Revenue Service, Rev. Proc. 2025-32, "Tax inflation adjustments for tax year 2026," Section 4.02 and Section 4.14, retrieved August 22, 2026. https://www.irs.gov/pub/irs-drop/rp-25-32.pdf
2. Internal Revenue Service, Topic no. 553, "Tax on a child's investment and other unearned income (kiddie tax)," retrieved August 22, 2026. https://www.irs.gov/taxtopics/tc553
3. Internal Revenue Service, Rev. Proc. 2025-32, "Tax inflation adjustments for tax year 2026," Section 4.14, dependent standard deduction, retrieved August 22, 2026. https://www.irs.gov/pub/irs-drop/rp-25-32.pdf
4. Internal Revenue Service, Publication 550 (2025), "Investment Income and Expenses," section "Income from property given to a child," retrieved August 22, 2026. https://www.irs.gov/publications/p550
5. Internal Revenue Service, Topic no. 313, "Qualified tuition programs (QTPs)," retrieved August 22, 2026. https://www.irs.gov/taxtopics/tc313
6. Internal Revenue Service, Publication 590-A (2025), "Contributions to Individual Retirement Arrangements (IRAs)," Roth IRA and QTP rollover sections, retrieved August 22, 2026. https://www.irs.gov/publications/p590a
7. Internal Revenue Service, Rev. Proc. 2025-32, "Tax inflation adjustments for tax year 2026," Section 4.42, annual exclusion for gifts, retrieved August 22, 2026. https://www.irs.gov/pub/irs-drop/rp-25-32.pdf
8. Internal Revenue Service, Instructions for Form 8615 (2025), parent election note, retrieved August 22, 2026. https://www.irs.gov/instructions/i8615

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