Who Pays Taxes on a Custodial Account: When the Kiddie Tax Kicks In

The child pays taxes on a custodial account because the account is legally the minor's property. However, the IRS kiddie tax (Form 8615) taxes unearned income above $2,700 in 2026 at the parent's marginal rate, which can reach 37%. This effectively shifts the tax burden from the child's low bracket to the parent's higher one.

A custodial account is taxed in the child's name, not the parent's. But the IRS's kiddie tax can push part of that income to the parent's higher rate. For 2026, the first $1,350 of a child's unearned income is tax-free, and the next $1,350 is taxed at the child's own rate. Anything above $2,700 may be taxed at the parent's marginal rate, which can reach 37% for high earners. This guide walks through the three-tier system, the filing rules, and the traps that catch parents by surprise.

The Short Answer: The Child Pays, With a Major Catch

A custodial account, whether it's a UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act) account, is legally owned by the minor. The adult serves as custodian but does not own the assets. Because the child is the owner, any income generated inside the account, interest, dividends, or capital gains, belongs to the child for tax purposes. That means the child, not the parent, is initially responsible for the tax bill.

But that's only half the story. The IRS imposes a special rule known as the kiddie tax, which prevents parents from shifting large amounts of investment income to a child's lower tax bracket. Once the child's unearned income crosses a set threshold, the excess is taxed at the parent's marginal rate. In 2026, the kiddie tax threshold is $2,700. Below that, the first $1,350 is tax-free and the next $1,350 is taxed at the child's own rate. Above $2,700, the parent's rate applies. A child with $5,000 in unearned income could see part of it taxed at 22%, 24%, or even 37%, the same rate the parent pays on their top dollar of earnings.

This structure creates a surprise for families who assumed the account would be taxed entirely at the child's low bracket. The rule is designed to curb income shifting, and it works. Parents who ignore it risk an unexpected tax bill and IRS penalties.

What makes a custodial account different from a joint account

A custodial account is an irrevocable gift to the child. The minor is the sole owner, and the custodian manages the account until the child reaches the age of majority, typically 18 or 21 depending on state law. A joint account, by contrast, is owned by two or more people, each with full rights to the funds. Joint accounts offer no tax advantage: the income is reported by the account holders according to their share of ownership. With a custodial account, the income is the child's alone, which is why the kiddie tax becomes relevant.

Why 'the child pays' is only half the story

Stating that the child pays the tax is technically correct but misleading. In practice, the parent often ends up paying, either because the child's investment income is substantial enough to trigger the kiddie tax at the parent's rate, or because the parent elects to report the child's income on their own return to simplify filing. The parent may also face gift tax reporting obligations when funding the account with large sums. Treating the custodial account as a simple tax dodge for the child's low bracket is a mistake.

Custodial Account Tax Rules: The 2026 Thresholds You Need to Know

The IRS sets three tiers for taxing a child's unearned income in 2026. These tiers apply to all children subject to the kiddie tax, generally those under 19, or under 24 if a full-time student. The thresholds are the same for federal income tax purposes, regardless of the type of custodial account.

Also worth reading: who has tax liability in a custodial account? 2026 irs rules.

Our deep dive who claims income on a custodial account? (2026 rules explores this question further.

Our deep dive custodial account taxes 2026: kiddie tax rules & the $2,700 explores this question further.

Here's how the three-tier system works:

• Tier 1: $0 to $1,350, completely tax-free. The standard deduction for a child with only unearned income shelters the first $1,350. No tax is owed on this portion.
• Tier 2: $1,351 to $2,700, taxed at the child's own rate. The next $1,350 is taxed using the child's tax bracket, which is usually 10% or 12% for most children with modest income.
• Tier 3: Above $2,700, taxed at the parent's marginal rate. This is the kiddie tax in action. The IRS requires the child to use the parent's highest tax rate on the excess, eliminating the benefit of shifting income to a lower bracket.

If the child also has earned income from a job, the rules become more complex. The standard deduction for a dependent with earned income can be higher, up to the earned income plus $400, but the kiddie tax still applies to unearned income above the $2,700 threshold. The IRS provides a worksheet in Publication 929 to calculate the tax in these mixed-income scenarios.

The first $1,350: tax-free

The first $1,350 of unearned income in 2026 is shielded by the standard deduction for a dependent child. This deduction applies automatically if the child has no earned income. Even a child with a part-time job can still claim this deduction on unearned income, as long as the combined deduction doesn't exceed the larger of $1,350 or earned income plus $400. For most families, this means the first $1,350 of interest, dividends, or capital gains distributions from a custodial account won't generate a tax bill.

The next $1,350: taxed at the child's rate

The $1,351 to $2,700 range is taxed at the child's own marginal rate. For a child with no other income, this typically means a 10% federal rate on the full $1,350. State taxes may apply separately. This tier is the only part of the custodial account's earnings that benefits from the child's lower bracket. Once the child's total unearned income crosses $2,700, the kiddie tax replaces the child's rate with the parent's for the excess.

Above $2,700: the kiddie tax applies

Every dollar of unearned income above $2,700 is taxed at the parent's marginal rate. The IRS uses the parent's highest tax bracket to compute the tax on Form 8615. If the parent is in the 24% bracket, for example, the child's excess investment income is taxed at 24%, not the child's 10% or 12% rate. This rule makes the custodial account far less tax-efficient than many parents expect, especially when the account holds high-growth stocks or ETFs that generate large capital gains.

What Is the Kiddie Tax, and Who Does It Actually Hit?

The kiddie tax is a federal tax rule that applies to a child's unearned income above an annual threshold. Its purpose is to prevent parents from transferring assets to a child in order to take advantage of the child's lower tax bracket. The tax is computed on IRS Form 8615, which the child must file (or the parent can file on the child's behalf).

Not every child is subject to the kiddie tax. The rules target children who are under 18 at the end of the tax year, or 18-year-olds whose earned income does not exceed half of their support. The tax also applies to full-time students ages 19 to 23 (under 24) whose earned income does not exceed half of their support. A child who is married and files jointly is generally exempt.

If the child's only income is unearned and totals less than $13,500, the parent may elect to report it on their own return using Form 8814 instead of the child filing a separate return. This election can simplify the process but doesn't change the amount of tax owed. The parent still pays tax on the child's income at the parent's rate for the portion above the thresholds.

Age rules: when does the kiddie tax stop applying?

The kiddie tax stops applying once the child reaches age 18 and is not a full-time student, or when the child turns 24 (even if still a student). At that point, all unearned income is taxed at the child's own rate, regardless of amount. This is the point where the tax benefit of a custodial account finally materializes, but only if the child hasn't already spent the funds on education or other expenses.

Which types of income count as 'unearned'?

Unearned income includes interest, dividends, capital gain distributions from mutual funds or ETFs, taxable refunds from state and local income taxes, and certain royalties. For custodial accounts holding stocks, bonds, ETFs, or crypto, both dividends and realized capital gains count as unearned income. Earned income from a job, wages, tips, self-employment income, is not subject to the kiddie tax, though it can affect the child's standard deduction and filing requirement.

Does the kiddie tax apply to custodial crypto or ETF gains?

Yes. The kiddie tax covers all unearned income, including capital gains from selling cryptocurrencies or ETFs held in a custodial account. A child who sells a bitcoin position held in a UGMA account and realizes a $4,000 gain will trigger the kiddie tax on the amount above $2,700. The parent's marginal rate applies to that excess. This is an area where many parents get tripped up, especially if they opened the account when crypto prices were low and the gains are substantial. If you're considering borrowing against crypto instead of selling it, the tax treatment is different, a non-custodial bitcoin loan, for example, may allow you to access liquidity without triggering a taxable event, though the rules around collateral and interest are separate from custodial account taxation.

Comprendre les règles fiscales est essentiel, notamment pour savoir si les prêts crypto sont imposables selon l'IRS pour 2026.

De même, il est essentiel de savoir si les prêts crypto sont imposables pour anticiper les implications fiscales de vos actifs numériques.

De même, comprendre si les prêts crypto sont imposables est crucial pour anticiper les implications fiscales de vos actifs numériques.

Il est important de comprendre les implications fiscales, notamment si les prêts crypto sont imposables selon les règles de l'IRS pour 2026.

Si vous vous intéressez à la fiscalité des actifs numériques, il est important de comprendre si les prêts crypto sont imposables selon les règles de l'IRS pour 2026.

De plus, si vous vous demandez si les prêts crypto sont imposables, les règles de l'IRS pour 2026 sont à prendre en compte.

Worked Example: A $5,000 Gain in a UTMA Account (2026)

To see the three-tier system in action, consider a 15-year-old child with a UTMA account that holds an S&P 500 ETF. During the year, the ETF pays $500 in dividends and the custodian sells shares for a $4,500 long-term capital gain. Total unearned income is $5,000. The child has no earned income.

Here's how the tax is calculated using the 2026 thresholds:

1. The first $1,350 is tax-free.
2. The next $1,350 is taxed at the child's rate. For long-term capital gains, the child's rate is 0% (if taxable income is below the 0% long-term capital gains bracket threshold). Qualified dividends also benefit from the 0% rate at this income level. So the tax on this portion is $0.
3. The remaining $2,300 ($5,000 minus $2,700) is taxed at the parent's marginal rate. If the parent's top bracket is 22% for ordinary income, but the gain is long-term, the parent's long-term capital gains rate applies, typically 15% for most brackets. So the tax on this portion is $345 (15% of $2,300).

Total federal tax bill: $0 + $0 + $345 = $345. State taxes may add more. If the same gain had been ordinary income (short-term capital gain), the $2,300 would be taxed at the parent's 22% rate, adding $506 to the bill. The difference between long-term and short-term gains matters enormously under the kiddie tax.

Step 1: Identify the type of income

The first step is to separate the child's income into earned and unearned. In this example, all income is unearned: $500 in dividends and $4,500 in capital gains. The type of unearned income matters for the applicable tax rate. Qualified dividends and long-term capital gains are taxed at preferential rates (0%, 15%, or 20%), while ordinary income, interest, non-qualified dividends, short-term capital gains, is taxed at ordinary income rates.

Step 2: Apply the three-tier kiddie tax formula

The formula is mechanical: subtract the $1,350 standard deduction, then apply the child's rate to the next $1,350, and the parent's rate to the rest. But the parent's rate is determined by the character of the income. If the excess is long-term capital gains, the parent's long-term capital gains rate is used. If it's ordinary income, the parent's ordinary marginal rate applies. This step is where many preparers make errors, especially when the child has a mix of income types.

Step 3: Who files, the child or the parent?

Since the child's unearned income is $5,000, which is above the $2,700 threshold, the child must file their own return using Form 8615 to compute the kiddie tax. The parent cannot use the Form 8814 election because the child's income is not solely interest and dividends (it includes capital gains). The child files a simple Form 1040 with the kiddie tax schedule attached. If the child's only income were $3,000 in interest and dividends, the parent could elect to report it on their own return using Form 8814, as long as the total is less than $13,500 (IRS Topic 553, June 2026).

Who Claims the Income on a Custodial Account? Filing Rules Explained

The income generated by a custodial account is always reported under the child's Social Security number. The child is the taxpayer. But the filing obligation can be satisfied in one of three ways, depending on the amount and type of income.

If the child's total unearned income is under $1,350, no tax return is required. If it's between $1,350 and $13,500 and consists solely of interest and dividends (including capital gain distributions), the parent may elect to include the income on their own return using Form 8814. This election avoids the need for a separate child's return. If the income exceeds $13,500, or includes any other type of unearned income such as capital gains from sales, the child must file their own return, typically with Form 8615 attached.

For most families with modest custodial accounts, the Form 8814 election is the simplest route. But it has a cost: the parent's adjusted gross income increases, which can affect eligibility for certain credits and deductions. The tax paid is the same regardless of the method chosen, because the kiddie tax still applies.

When the child must file their own return

A child must file their own return if they have more than $1,350 in unearned income and the parent cannot or does not elect to report it. The child must also file if they have earned income above the standard deduction. For 2026, the standard deduction for a dependent with earned income is the greater of $1,350 or earned income plus $400, up to the full standard deduction for a single filer. The child's return is filed under their own name and SSN, and the child (or parent) signs it.

The parent election: Form 8814 and its trade-offs

Form 8814 allows a parent to report a child's interest and dividend income on the parent's return if the total is less than $13,500. The child must not have filed a joint return, and the income must be only from interest and dividends (including capital gain distributions from mutual funds or ETFs). The election is made on the parent's Form 1040. The parent pays tax on the child's income after the first $1,350 exempt amount, plus an additional 10% surtax on the next $1,350. This method can be convenient but adds complexity to the parent's return and may push the parent into a higher bracket or trigger phaseouts.

Gift tax considerations: contributions to a custodial account

Funding a custodial account is a gift to the child. Gifts are subject to the annual gift tax exclusion, which allows a certain amount per donor per recipient each year without triggering a gift tax return. Amounts above that exclusion require filing Form 709. Gifts to a custodial account are irrevocable, once the asset is transferred, it belongs to the child. The donor's cost basis carries over to the child, which can affect the gain when the child sells the asset. This carryover basis is a detail many parents overlook, but it directly impacts the capital gains tax the child will eventually owe.

The Most Common Mistake Parents Make With Custodial Account Taxes

The single biggest mistake parents make is assuming a custodial account works like a 529 plan. They believe the earnings grow tax-free or are tax-deferred until withdrawal. That's not the case. A custodial account is a taxable investment account owned by the child, and every dividend, interest payment, and realized capital gain is taxable in the year it occurs. The kiddie tax can amplify the bite by applying the parent's rate.

This misunderstanding often surfaces when the account has grown significantly and the custodian sells assets to pay for college. The family expected no tax bill, but instead faces a surprise liability at the parent's marginal rate. The contrast with 529 plans is stark: 529 plan earnings are not subject to federal tax when used for qualified education expenses (IRS, January 2026). Coverdell Education Savings Accounts also offer tax-free withdrawals for qualified expenses, though with lower contribution limits and income phaseouts (IRS Topic 310, February 2026).

A custodial account offers no such shelter. It's a general-purpose investment account that happens to be in the child's name. The tax treatment is identical to any individual brokerage account, modified only by the kiddie tax thresholds.

Custodial accounts vs. 529 plans: the tax treatment gap

A 529 plan allows contributions to grow tax-deferred, and withdrawals are tax-free at the federal level when used for qualified education expenses. A custodial account offers no tax deferral. Dividends and interest are taxed annually. Capital gains are triggered when securities are sold, regardless of whether the proceeds are spent on education. The only tax advantage is the small $1,350 exemption and the chance to use the child's lower rate on the next $1,350, a benefit that disappears once the kiddie tax kicks in.

What happens if you miss the kiddie tax filing requirement

Failing to file Form 8615 or failing to report the child's income correctly can result in IRS penalties and interest. The IRS matches 1099 forms issued by brokers to the child's SSN. If a return isn't filed, the IRS may send a notice proposing additional tax. The penalties for underpayment of tax apply to the child's account, but the parent as custodian typically handles the liability. In practice, the IRS often catches these errors when the child's 1099 reports income that never appears on any return. Amending past returns and paying back taxes with interest is the usual fix.

Capital Gains Tax on Custodial Accounts: Short-Term vs. Long-Term

When a custodial account sells an asset for a profit, the resulting capital gain is taxed to the child. The rate depends on how long the asset was held and whether the kiddie tax applies. If the child is taxed at the child's own rate (on the $1,351 to $2,700 portion), long-term capital gains are typically taxed at 0% for most children with low income. Short-term gains are taxed as ordinary income, at the child's marginal rate.

Once the kiddie tax applies, the parent's rate determines the tax on the excess. For long-term gains, the parent's long-term capital gains rate applies, which is usually 15% or 20% for higher-income parents. For short-term gains, the parent's ordinary income rate applies, which can be as high as 37%. This differential makes the holding period critical. Parents who actively trade in a custodial account, generating short-term gains, can create a significantly larger tax bill than if they had held the assets for more than a year.

How cost basis transfers when assets are gifted to the account

When a parent or grandparent gifts shares of stock or crypto to a custodial account, the child inherits the donor's cost basis. If the donor bought the asset for $10,000 and it is worth $15,000 when gifted, the child's basis is $10,000. When the child sells, the $5,000 gain is taxable to the child. This carryover basis rule prevents donors from shifting unrealized gains to a child's lower tax bracket without triggering tax. It's a critical detail that affects the after-tax return of the custodial account.

Long-term vs. short-term capital gains inside a UGMA/UTMA

Long-term gains (assets held more than one year) benefit from lower tax rates. Under the kiddie tax, the parent's long-term rate is applied to the excess above $2,700, which is almost always lower than the parent's ordinary rate. Short-term gains are taxed at ordinary rates, both for the child's portion and the parent's portion. The tax bill on a $5,000 short-term gain at a 22% parent rate is $506 on the excess alone, compared to $345 for a long-term gain at 15%. The difference is $161, and it grows with larger gains. This gap is a strong incentive to invest for the long term in a custodial account.

Tax Benefits of a Custodial Account, and Their Real Limits

The primary tax benefit of a custodial account is the ability to shift a modest amount of investment income to a child's lower tax bracket. The first $1,350 is tax-free, and the next $1,350 is taxed at the child's rate, which is often 0% for long-term capital gains and qualified dividends. This can save a few hundred dollars per year compared to holding the same assets in the parent's taxable account.

But the benefit is capped. Once unearned income exceeds $2,700, the parent's rate applies, eliminating the advantage. The kiddie tax effectively neutralizes the income-shifting strategy for larger accounts. The real benefit emerges only after the child reaches the age where the kiddie tax no longer applies, typically 18 or 24. At that point, the child can sell assets and pay tax at their own (often lower) rate. Until then, the custodial account is a taxable vehicle with a very limited tax shield.

Quick-Reference Table: Custodial Account vs. 529 vs. Coverdell Tax Treatment (2026)

The table below summarizes the key tax differences between the three most common education savings vehicles:

This comparison highlights the fundamental trade-off: custodial accounts offer flexibility but no tax shelter, while 529 plans and Coverdell ESAs provide tax-free growth for education but restrict how the money can be used.

Key points

• Custodial accounts are taxed in the child's name, but the kiddie tax can push unearned income above $2,700 into the parent's tax bracket (IRS, 2026).
• The first $1,350 of unearned income is tax-free; the next $1,350 is taxed at the child's rate before the parent's rate kicks in.
• Parents can elect to report a child's income on their own return if it's under $13,500 and consists solely of interest and dividends (IRS Topic 553, 2026).
• Unlike 529 plans, custodial accounts are not tax-deferred; selling assets can trigger capital gains that the child (or parent) must pay that year.
• Missing the kiddie tax filing requirement may result in IRS penalties and interest, so it's critical to file Form 8615 or Form 8814 when required.

Sources

• irs.gov
• irs.gov
• irs.gov
• irs.gov
• nerdwallet.com

This content is educational and should not be read as an investment recommendation. Speak with a licensed advisor for guidance tailored to your circumstances.