The Kiddie Tax is an alternate, higher rate of calculating tax due that applies to young people. While it was intended to ensure that wealthy parents paid their full share of tax on their investments, it also sometimes applies to graduate students whose income comes primarily from a fellowship or training grant.
If you have found this article through search, it’s likely that your (software or human) tax preparer has determined that you owe the Kiddie Tax. This article will help you understand what the Kiddie Tax is, who it applies to, how it is calculated, and how to avoid it in the future.
What is the Kiddie Tax?
Back in the early 1980s, finding tax shelters (i.e., legal ways to avoid paying tax) was all the rage because tax rates were much higher than they are today. The top marginal tax rate was reduced to 50% in 1981 and finally to 28% in 1988 with the last major tax reform prior to the Tax Cuts and Jobs Act (source).
One of the tax shelters was for parents to put income-generating assets in their minor children’s names. The children were (presumably) in much lower tax brackets for investment income than their parents, so overall the family paid less in tax for those assets (source).
In 1986, the “Kiddie Tax” was enacted to close this loophole. Under the Kiddie Tax, a child or young adult’s unearned income is taxed at a higher rate than it would be if they were older (with all other factors being the same).
How Does the Kiddie Tax Affect PhD Students?
The way the Kiddie Tax is written and structured makes sense for the purpose of preventing wealthy parents from sheltering their income using their children. However, it has an off-label effect on PhD students.
The Kiddie Tax applies to all children through age 17, some children through age 18, and some students through age 23. It applies to “unearned income,” which includes not only investment income but also income from fellowships, scholarships, and training grants.
This means that a graduate student under the age of 23 whose income is from a fellowship may be taxed not at the ordinary income rates that they will be at age 24+ but rather at their parents’ marginal tax rate (if it is higher than their own).
(The Tax Cuts and Jobs Act, passed at the end of 2017, changed the alternate tax rate to be the one used for estates and trusts rather than the parents’ marginal tax rate, which it had been historically. This negatively affected college students from low-income backgrounds, who are often funded by scholarships and grants. At the end of 2019, the Kiddie Tax rate was changed back to the marginal tax rate of the parents, which was also retroactively applied for 2018. If you paid the Kiddie Tax in 2018, an amended return may be warranted.)
The PhD students most in danger of the Kiddie Tax applying to them in a way that will massively increase their tax due are those who received fellowship (awarded) income for an entire calendar year, e.g., January of the first year through December of the second year.
Who Has to Pay the Kiddie Tax?
The Kiddie Tax does not apply to every graduate student on fellowship, though it applies to many.
The instructions for Form 8615 lay out who has to file the form and (potentially) pay the Kiddie Tax. There are five qualifications for being subject to the Kiddie Tax, all of which must apply. If any one of the following is not true for you, you aren’t subject to the Kiddie tax.
1) You had more than $2,200 of unearned income.
Taxable fellowship and scholarship income counts as “unearned income.”
The definition of “unearned income” from p. 1 of the instructions for Form 8615 is:
“For Form 8615, “unearned income” includes all taxable income other than earned income. Unearned income includes taxable interest, ordinary dividends, capital gains (including capital gain distributions), rents, royalties, etc. It also includes taxable social security benefits, pension and annuity income, taxable scholarship and fellowship grants not reported on Form W-2, unemployment compensation, alimony, and income (other than earned income) received as the beneficiary of a trust.”
2) You are required to file a tax return.
The Form 1040 instructions (p. 8-11) answer the question of who has to file a return for 2019.
Chart A (p. 9) is for most people under age 65. It states that you must file a return if you are single and your gross income is at least $12,200.
Chart B (p. 10) is for dependents. You are required to file a tax return if you are single and:
- “Your unearned income was over $1,100.
- Your earned income was over $12,200.
- Your gross income was more than the larger of
- $1,100, or
- Your earned income (up to $11,850) plus $350″
For the purpose of Chart B only, taxable scholarships and fellowships are “earned income” while “unearned income” includes taxable interest, ordinary dividends, and capital gains distributions.
If your gross income was less than $11,850 and your unearned income (taxable interest, ordinary dividends, and capital gains distributions) was less than $350, you do not need to file a tax return and are not subject to the Kiddie Tax.
Alternatively, you can use the IRS’s Interactive Tax Assistant to determine whether you are required to file a return: Do I Need to File a Tax Return?
3) You are a student under age 24
To be subject to the Kiddie Tax, you must be (Form 8615 p. 1):
- “Under age 18 at the end of 2019,
- Age 18 at the end of 2019 and didn’t have earned income that was more than half of your support, or
- A full-time student at least age 19 and under age 24 at the end of 2019 and didn’t have earned income that was more than half of your support.”
Full-Time Student Status
Form 8615 refers to Publication 501 for the definition of ‘full-time student’ (p. 12):
“To qualify as a student, your child must be, during some part of each of any 5 calendar months of the year:
- A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school, or
- A student taking a full-time, on-farm training course given by a school described in (1), or by a state, county, or local government agency.
The 5 calendar months don’t have to be consecutive.
Full-time student. A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.”
You do not have to be a student throughout the calendar year to be defined as a student and subject to the Kiddie Tax. You are considered a student if you are a full-time student in (part of) 5 calendar months, which do not have to be consecutive.
Defining support and who/what provided it is the trickiest part of determining whether you are subject to the Kiddie Tax. First, you must determine your support, and then calculate whether your earned income amounted to more than half of your support.
The Form 8615 instructions defines support as (p. 1):
“Support. Your support includes all amounts spent to provide you with food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. To figure your support, count support provided by you, your parents, and others. However, a scholarship you received isn’t considered support if you’re a full-time student. For details, see Pub. 501, Dependents, Standard Deduction, and Filing Information.”
Publication 501 includes the Worksheet for Determining Support (p. 15), which you must go through in detail. Your support is the amount of money that is used to pay all your living, education, medical, and travel expenses. The education expenses include the tuition, fees, etc. for your graduate degree.
If you do not have earned income totaling at least half of your own support, you may be subject to the Kiddie Tax. Scholarships and fellowships do not count as earned income for this purpose.
The support test being calculated this way creates a very high bar for funded graduate students as tuition can easily rival or exceed living expenses.
4) At least one of your parents was alive at the end of the year
If your parents (including adoptive and step-parents) are deceased, the Kiddie Tax does not apply to you.
5) You don’t file a joint return
If you are single, the Kiddie Tax may apply to you. If you are married filing jointly, the Kiddie Tax does not apply to you.
If you meet all five of these criteria, you need to fill out Form 8615, as the Kiddie Tax may apply to you.
How Is the Kiddie Tax Calculated?
Form 8615 calculates your Kiddie Tax. Part I calculates your net unearned income, and Part II calculates your tax.
You should carefully fill out each line and read the instructions to find the correct definitions. I have highlighted some points about each line specific to fellowship recipients, but you still need to read the full instructions.
Line 1 asks for your “unearned income” as defined above. If you had no earned income (i.e., you were 100% on fellowship for the calendar year and had no other income sources), you can use the value from your Form 1040 Line 1. If you had both earned and unearned income, you need to fill out the Unearned Income Worksheet (p. 2 of the form instructions), which subtracts your earned income from your total income.
If you took the standard deduction, enter $2,200. If you itemized your deductions on Schedule A, there is a different formula to use in the instructions.
Line 3 = Line 1 – Line 2
If the value in Line 3 is 0 or negative, you do not have to pay the Kiddie Tax. (Translation: If you took the standard deduction and your unearned income is less than $2,100, you do not have to pay the Kiddie Tax.)
Enter in Line 4 your taxable income from Form 1040 Line 11b (your gross income minus all relevant deductions).
Enter in Line 5 the smaller of the values in Line 3 and Line 4.
To calculate your tax, you have to use the Line 7 Tax Computation Worksheet on p. 4 of the instructions or the Tentative Tax Based on the Tax Rate of Your Parent Worksheet on p. 5. The first worksheet applies the tax rates for estates and trusts to your unearned income; it is likely more advantageous to you to elect to use the second worksheet, but you will need to know your parents’ and siblings’ incomes for the calculation.
How to Avoid the Kiddie Tax
Once a tax year ends, you run out of opportunities to avoid the Kiddie Tax. To avoid the Kiddie Tax in the current or a future tax year, make sure that at least one of the five above points on who the Kiddie Tax doesn’t apply to is true for you. For example, you could:
- Delay your matriculation into grad school
- Configure your income and expenses such that you pass the support test, e.g.,
- Request that you are paid by an assistantship instead of a fellowship for part or all of the calendar year
- Earn a significant side income
- Get married and file a joint return.
- Find every applicable qualified education expense to make more of your fellowship income tax-free (e.g., your student health insurance premium if paid by scholarship)
How to Minimize the Kiddie Tax
If you are subject to the Kiddie Tax, the best thing to do is minimize your unearned income and taxable income. If you have any influence with your parents and they are willing and able to minimize their taxable income, please ask them to do the same.
You can minimize your unearned (awarded) income by making as much of it tax-free as possible using your qualified education expenses. This is largely accomplished more or less automatically, but please be thorough in tracking down and documenting every possible qualified education expense, such as course-related expenses and certain fees. Box 1 of your Form 1098-T is likely not the full sum of your qualified education expenses for this purpose.
You can minimize your taxable income by taking additional above-the-line deductions or adjustments to income, such as contributing to a traditional IRA (through April 15 of the subsequent year) or paying student loan interest (during the tax year).
The fact that fellowship income triggers the Kiddie Tax is unconscionable and potentially highly financially damaging to an already vulnerable population, graduate students funded by fellowship or awarded income. Despite their lack of earned income, these graduate students are typically financially independent from their parents, so their parents’ income, even if high, is immaterial to their lives. This aspect of our tax code desperately needs reform; however, I am not hopeful that it will be reformed in the near future as it has withstood two recent tax code updates.
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