How to Shift Income to Your Child in a Lower Tax Bracket

To shift income to a child in a lower tax bracket, the reliable move is to generate earned income for the child, usually by employing them in a family business, and to route savings through accounts the tax code already favors: a 529 plan, a Roth IRA funded by the child’s wages, and, more cautiously, a custodial account. Shifting investment income directly to a child runs into the Kiddie Tax almost immediately, so the strategies that work are the ones built around wages and tax-advantaged accounts rather than around parking a brokerage account in your kid’s name.

Everything below flows from that split. Earned income belongs to the child at the child’s rate. Unearned income above a small floor gets pulled back to your rate no matter whose name is on the account.

The Kiddie Tax Sets the Ceiling on Unearned Income

Congress built the Kiddie Tax specifically to stop parents from parking investment assets in a child’s name and enjoying the child’s low bracket on the returns. It targets unearned income: dividends, interest, capital gains, and trust distributions. Wages from a real job are not affected.

For 2026, a child’s unearned income is taxed in three tiers:

That third tier is the whole reason simple asset-shifting fails. Once your child’s investment income crosses $2,700, the savings evaporate because the income is taxed as if you earned it.

The rule applies to a child who is under 18 at year-end, age 18 without earned income covering more than half their support, or a full-time student aged 19 to 23 in the same support situation. The child needs at least one living parent and a filing requirement. The calculation goes on Form 8615, attached to the child’s return.2Internal Revenue Service. Instructions for Form 8615, Tax for Certain Children Who Have Unearned Income

Keep this ceiling in mind for every strategy that follows. It is the reason employment beats asset transfers, and why 529 plans and Roth IRAs beat custodial brokerage accounts.

Employ Your Child in the Family Business

If you run a business, hiring your child is the cleanest income shift available. You deduct the wages as a business expense at your marginal rate. Your child receives earned income, which is not touched by the Kiddie Tax, and shelters most or all of it with their own standard deduction.

A dependent’s 2026 standard deduction equals the greater of $1,350 or their earned income plus $450, capped at the regular single-filer standard deduction.3Internal Revenue Service. Topic No. 551, Standard Deduction A child earning $14,600 in wages would have a standard deduction of $15,050 (or the single-filer cap, whichever is less), meaning little to none of that pay faces federal income tax. Your business deducts every dollar of it at your rate.

Payroll Tax Exemptions for Kids on the Payroll

The wage strategy has a second layer of savings. When a sole proprietorship, or a partnership where both partners are the child’s parents, pays wages to a child under 18, those wages are exempt from Social Security and Medicare taxes. That removes 6.2% Social Security tax and 1.45% Medicare tax on both employer and employee sides, a combined 15.3% saving on every dollar paid. Wages paid to a child under 21 in the same structures are also exempt from federal unemployment tax.4Internal Revenue Service. Family Employees

Neither exemption applies if the business is a corporation or if the partnership includes any non-parent partner. This is a significant structural detail: an S corporation loses the payroll tax break entirely.

Real Work, Reasonable Pay, Real Records

This is where families get sloppy, and it is exactly where the IRS looks. The employment has to be genuine. Your child needs to do actual work the business needs, at a rate that matches what an unrelated person would earn for the same tasks. A 12-year-old billing $50 an hour to stuff envelopes will not survive a review.

Keep the same records you would for any employee: a written job description, time logs, a W-2 at year-end. The IRS does not object to hiring family. It objects to disguising an allowance as a business deduction.

Route the Child’s Wages Into a Roth IRA

Once your child has earned income, they can contribute to a Roth IRA. The 2026 limit is $7,500 or 100% of the child’s earned income, whichever is less.5Internal Revenue Service. Retirement Topics, IRA Contribution Limits A parent or grandparent can fund the contribution on the child’s behalf as long as the child actually earned at least that amount during the year.

Contributions go in after tax. Growth and qualified retirement withdrawals come out tax-free. A teenager’s Roth has 50 or more years to compound. Paired with the family-business wage strategy, the same dollar can be deducted at your rate, sheltered by the child’s standard deduction on the way in, and never taxed again on the way out.

Fund Education Through a 529 Plan

A 529 plan is the cleanest way to move wealth toward a child’s education without triggering the Kiddie Tax at all. Contributions are not deductible federally, but investment growth inside the account is never taxed as long as withdrawals go to qualifying education expenses.6Internal Revenue Service. 529 Plans, Questions and Answers

Qualifying higher-education expenses cover tuition, fees, books, and room and board. Starting in 2026, the annual limit for K-12 expenses is $20,000 per beneficiary across all of that beneficiary’s 529 accounts, up from $10,000. The expanded K-12 use also covers tutoring, standardized test fees, and educational therapy for students with disabilities.7Internal Revenue Service. Topic No. 313, Qualified Tuition Programs (QTPs)

Under the SECURE 2.0 Act, unused 529 funds can now be rolled directly into the beneficiary’s Roth IRA. The 529 must have been open at least 15 years, the transferred amount must come from contributions made at least five years before the rollover, the annual rollover cannot exceed that year’s Roth IRA contribution limit, and there is a $35,000 lifetime cap per beneficiary.8Office of the Law Revision Counsel. 26 U.S.C. 529 – Qualified Tuition Programs Overfunding a 529 carries far less risk than it used to.

Custodial Accounts and Trusts: Limited Use

Custodial accounts under UGMA or UTMA let you irrevocably transfer assets to a child, with an adult managing them until the child reaches the age of majority, generally between 18 and 21 depending on the state.9HelpWithMyBank.gov. Uniform Gifts to Minors Account (UGMA) or Uniform Transfers to Minors Act (UTMA) Investment income inside sits squarely under the Kiddie Tax tiers, so the tax benefit is modest: only the first $2,700 of unearned income is taxed favorably.

Two other trade-offs matter. On the FAFSA, custodial accounts are reported as the child’s asset, which is assessed at a higher rate than a parent’s asset and can shrink financial aid. And at the age of majority, the child owns the money outright, whatever their maturity or plans.

Trusts give parents more control over when and how the child receives assets, but the tax cost is real. Undistributed trust income is taxed at the trust’s own compressed rates: in 2026, a trust hits the 37% bracket at just $16,000 of taxable income, while an individual does not reach 37% until income exceeds $640,600.10Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Retaining income in a trust for control can produce a worse tax outcome than simply paying your own rate. Section 2503(c) minor’s trusts and Crummey trusts can qualify contributions for the annual gift exclusion, but each has structural constraints and needs professional drafting.

Gift Tax Rules Behind Every Transfer

Any transfer to a child, whether into a custodial account, a trust, or a 529 plan, is a gift for federal tax purposes. For 2026, each donor can give up to $19,000 per recipient per year without filing a gift tax return or touching the lifetime exemption.11Internal Revenue Service. Gifts and Inheritances FAQs

Married couples can gift-split, treating a gift from one spouse as coming equally from both and effectively allowing up to $38,000 per recipient per year. Gift splitting requires filing Form 709 even when no tax is owed, and both spouses must consent to split all gifts made during the year. Any gift above the annual exclusion also triggers a Form 709 filing, though no tax is due until the donor exceeds the 2026 lifetime exemption of $15,000,000.12Internal Revenue Service. What’s New, Estate and Gift Tax

Where the IRS Draws the Line

Income shifting is legal when done properly. The IRS uses the assignment of income doctrine to stop taxpayers from simply redirecting income they earned to someone else. Income is taxed to the person who earned it or who controls the asset producing it, regardless of who receives the money. Diverting business profits to a child who does no real work will get those profits taxed back to you, with penalties possible.

For the employment strategy, the two triggers the IRS scrutinizes hardest are whether the work is genuine and whether the pay is reasonable. Look at what you would pay an unrelated person for the same work in your area. That is the ceiling. Overpaying a child risks reclassification of the excess as a nondeductible gift and invites a broader look at your return.

For transfers into trusts or custodial accounts, the gift must be genuine and irrevocable. If you fund a UGMA but keep trading the account as your own, or set up a trust while retaining the power to pull the assets back, the IRS will treat the income as still yours. A real shift in ownership and control is the whole point.

State rules add another layer. Some states do not conform to every federal provision described here, and a few treat trust income or the Kiddie Tax differently. Talk to a tax professional who knows your state’s rules before putting any of this in motion.