Yes, custodial accounts are taxable. A UGMA or UTMA account gets no tax deferral and no tax-free growth: interest, dividends, and capital gains are taxed in the year they’re earned, and the child is the legal owner for tax purposes. Small amounts of income are sheltered by the child’s standard deduction, but once unearned income clears $2,700, the “kiddie tax” applies the parent’s marginal rate to the excess.
How the Income Is Taxed Each Year
Money inside a custodial account doesn’t grow tax-deferred the way it would in a 529 plan or Roth IRA. Every dividend paid, every bond coupon received, and every gain realized on a sale is reportable that year, whether the cash leaves the account or gets reinvested.
The IRS calls this “unearned income” because it comes from assets rather than work.1Internal Revenue Service. Topic No. 553, Tax on a Child’s Investment and Other Unearned Income (Kiddie Tax) Because the child owns the assets, the income belongs on the child’s return, not the parent’s. What changes with the amount is the rate.
The Kiddie Tax Tiers
The kiddie tax exists to stop families from parking investments in a child’s name to grab a lower bracket. It applies to children under 19, and to full-time students under 24 whose earned income doesn’t cover more than half of their own support.2Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed Once the child ages out, all investment income is taxed at the child’s own rate.
For 2026, unearned income falls into three tiers:
- The first $1,350 is tax-free, absorbed by the dependent’s standard deduction.
- The next $1,350 is taxed at the child’s own rate, typically 10%.
- Anything above $2,700 is taxed at the parent’s marginal rate, whatever that rate is.
Say a child earns $5,000 in interest and dividends. The first $1,350 owes nothing. The next $1,350 is taxed at 10%, or $135. The remaining $2,300 is taxed at the parent’s bracket, whether that’s 24%, 32%, or higher. The thresholds are adjusted for inflation each year.3Internal Revenue Service. Instructions for Form 8615, Tax for Certain Children Who Have Unearned Income
The upshot: below $2,700 the tax savings from holding investments in a child’s name are modest, and above it they disappear entirely.
Who Files, and Which Form
Whether a return is required depends on how much the account produced during the year.
If the child’s unearned income for the year is $1,350 or less and there’s no earned income, no return is required. The standard deduction wipes out the liability.1Internal Revenue Service. Topic No. 553, Tax on a Child’s Investment and Other Unearned Income (Kiddie Tax)
Above that floor, the child files Form 1040. When the kiddie tax applies, Form 8615 is attached to calculate the portion taxed at the parent’s rate; filling it out requires the parent’s Social Security number and taxable income.3Internal Revenue Service. Instructions for Form 8615, Tax for Certain Children Who Have Unearned Income
The Form 8814 Shortcut
If the child’s only income is interest and dividends (including capital gain distributions) and the total is less than $13,500, the parent can file Form 8814 and pull the child’s income onto the parent’s own return. That avoids filing a separate return for the child.4Internal Revenue Service. Instructions for Form 8814, Parents’ Election to Report Child’s Interest and Dividends
The trade-off: the child’s income lifts the parent’s adjusted gross income, which can shrink education credits and other AGI-sensitive tax breaks. Families sitting near a phaseout threshold usually come out ahead filing the child’s own return, even with the extra paperwork.
Capital Gains and Carryover Basis
When appreciated stock is transferred into a custodial account, the child inherits the donor’s original cost basis rather than the market value at the time of the gift. This is called carryover basis.5Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust The holding period carries over too, so shares the donor already held long-term stay long-term in the child’s hands.
The effect matters most for highly appreciated shares. Stock bought at $10 and transferred at $50 gives the child a basis of $10, not $50. When the child sells, the entire $40 per share is a taxable gain, and if the kiddie tax still applies, that gain above the $2,700 threshold is taxed at the parent’s rate. Gifting cash and letting the child buy fresh shares at today’s price is often cleaner than transferring stock with a large embedded gain.
Are Contributions Taxable?
Contributions are gifts, not deductible income for the donor and not taxable income for the child. For federal gift tax purposes, contributions up to the annual exclusion, $19,000 per recipient in 2026, generate no gift tax and require no gift tax return.6Internal Revenue Service. What’s New – Estate and Gift Tax Two parents can each give $19,000 to the same child’s account, for $38,000 combined, without triggering the gift tax. Contributions above the exclusion eat into the donor’s lifetime exemption and require filing a gift tax return.7Office of the Law Revision Counsel. 26 USC 2503 – Taxable Gifts
One thing to be clear on before funding an account: contributions are irrevocable. Once the money goes in, it belongs to the child. The donor cannot pull it back, redirect it to another beneficiary, or use it for expenses a parent is already legally obligated to cover.
Keeping the Annual Tax Bill Low
The kiddie tax rewards patience and a light-income portfolio. A few practical moves can keep the account from generating an oversized bill every April.
Favor Growth Over Income
Stocks and funds that pay little or no current dividend produce less taxable income each year. Gains stay unrealized until shares are sold, which helps keep the child under the $2,700 threshold.3Internal Revenue Service. Instructions for Form 8615, Tax for Certain Children Who Have Unearned Income Broad growth-oriented index funds tend to distribute less than income-focused or actively managed funds.
Wait Out the Kiddie Tax Before Selling
Selling appreciated shares while the kiddie tax applies pushes gains above $2,700 into the parent’s bracket. Holding until the child turns 19, or 24 for a qualifying full-time student, shifts those gains to the child’s own rate.2Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed A young adult with modest wages can often sell appreciated stock and pay 0% federal tax on long-term capital gains, provided total taxable income stays below roughly $49,000.
Consider Municipal Bonds for the Bond Sleeve
Municipal bond interest is generally exempt from federal income tax and doesn’t count toward the kiddie tax threshold. For the fixed-income portion of a custodial portfolio, munis can be a reasonable substitute for taxable bonds or CDs, especially when the parent sits in a high bracket.
Track Income Through the Year
Dividends, interest, and realized gains add up quietly. If the account is closing in on $2,700 by summer, deferring a planned sale or moving out of a dividend-heavy fund before year-end can hold the child’s income in the lower-taxed zone. That kind of light-touch monitoring is the difference between a custodial account that pays a small tax bill and one that pays a large one it didn’t need to.