Kiddie Tax Rules for 2025: How Houston Families Can Avoid Surprises

If your child has investments, you need to understand how the Kiddie Tax works in 2025. Many parents are surprised when their child’s dividends, interest, or capital gains are not taxed at the child’s lower rate. Once income passes certain limits, the IRS applies the parent’s tax rate. That can make a big difference for families who are saving or investing in their children’s names.

At Clear Lake Taxes and Bookkeeping, we specialize in helping families in the Houston, Clear Lake, League City, and Friendswood areas understand IRS rules like the Kiddie Tax. Here’s what you should know this year.

What Is the Kiddie Tax?

The Kiddie Tax is designed to prevent parents from lowering their tax bill by shifting investments into a child’s name. It applies if your child is:

• Under 18 at the end of 2025, or

• A full-time student between ages 19 and 23 who does not provide more than half of their own support.

It applies only to unearned income, which includes:

• Dividends and interest

• Capital gains

• Rental property income

• Taxable scholarships or trust income

It does not apply to earned income such as wages or self-employment.

Kiddie Tax Thresholds for 2025

For tax year 2025, the rules are:

• The first $1,350 of a child’s unearned income is tax-free.

• The next $1,350 is taxed at the child’s rate.

• Any unearned income above $2,700 is taxed at the parent’s marginal tax rate.

Short-Term vs. Long-Term Capital Gains

This is where families often get confused. The Kiddie Tax does not treat all capital gains equally.

• Short-term capital gains (investments held for less than one year) are taxed as ordinary income. Under the Kiddie Tax, these gains are applied first. They fill up the child’s deduction and lower brackets before anything else. Once those amounts are used up, any remaining short-term gains are taxed at the parent’s higher rate.

• Long-term capital gains (investments held for more than one year) can qualify for the child’s 0% long-term capital gains rate up to certain limits. After that, the excess can also get pulled into the parent’s rate through the Kiddie Tax.

The order matters. Short-term capital gains are always used up first, which means long-term capital gains only benefit from the 0% bracket if there is still room left after short-term income is applied.

Example of the Kiddie Tax in 2025

Suppose your 16-year-old has $5,000 of unearned income in 2025, made up of $2,000 in short-term gains and $3,000 in long-term gains. Here’s how it would be treated:

• $1,350 of income is tax-free, applied against short-term gains first.

• The next $1,350 is taxed at the child’s rate. That also comes from short-term gains before long-term gains are considered.

• The remaining $2,300 is subject to the Kiddie Tax at the parent’s marginal rate.

• Some of the long-term gains may still qualify for the 0% rate, but once thresholds are exceeded, the rest will be taxed at the parent’s rate.