A Kiddie Tax Strategy for Business Owners

Business owners often spend years looking for ways to shift income, build family wealth, and reduce future capital gain exposure.

One underused strategy is straightforward: transfer investment assets to children, let those assets produce modest passive income, and intentionally harvest gains each year inside the child’s low-tax window.

This is not a strategy for eliminating tax on unlimited income. It is an annual planning discipline. The advantage comes from understanding where the kiddie tax starts — and where it does not start.

Why Business Owners Should Care

For high-income business owners, income location matters. If the parent owns the investment account, the dividends, interest, and capital gains generally land on the parent’s tax return.

If the child owns the investment account, the income generally starts on the child’s return, subject to the kiddie-tax rules.

That ownership shift can matter over time. It can help move wealth to the next generation, reduce future embedded gains, and use the child’s annual unearned-income window in a disciplined way.

The strategy is not about being aggressive. It is about using the rules deliberately and keeping the reporting clean.

The Basic Strategy

A parent gifts assets to a child, often into a custodial brokerage account or another child-owned structure.

After the transfer, those assets belong to the child. The dividends, interest, and gains produced by those assets are generally the child’s income, even if the assets originally came from the parent.

That creates a planning opportunity. The family can choose low-turnover, tax-efficient investments and monitor the child’s annual unearned income.

If there is room before the kiddie-tax threshold is reached, the family can intentionally harvest long-term capital gains, reinvest the proceeds, and raise the child’s basis over time.

First, Who Counts as a Dependent?

For many business-owner families, the child will be a qualifying child dependent.

In general, that means the child must satisfy five core tests:

• Relationship: the child is your son, daughter, stepchild, eligible foster child, sibling, or a descendant of one of those people.
• Age: the child is under age 19, under age 24 and a full-time student, or permanently and totally disabled.
• Residency: the child lives with you for more than half the year, subject to certain exceptions.
• Support: the child does not provide more than half of their own support for the year.
• Joint return: the child does not file a joint return, except in limited refund-only situations.

Do not confuse the dependent rules with the kiddie-tax rules.

The kiddie tax can apply even if the child is not claimed as a dependent. For Form 8615 purposes, the rules generally apply to children under 18, certain age-18 children who do not have earned income over half their support, and full-time students ages 19 through 23 who do not have earned income over half their support.

How the Kiddie-Tax Tiers Work

For 2026, it helps to think about a child’s unearned income in three federal layers.

Unearned income includes taxable interest, dividends, capital gains, capital gain distributions, rents, royalties, and certain trust income.

Earned wages from a legitimate job are a different category and are not the focus of this strategy.

Why Tax-Efficient ETFs Make the Strategy Powerful

Suppose a child owns a low-turnover, broad-market ETF with a 1% qualified dividend yield.

At that yield, the account can be much larger than many parents expect before the annual dividend income alone reaches the kiddie-tax threshold.

At roughly $270,000, a 1% dividend yield produces $2,700 of annual income. That is the full 2026 kiddie-tax threshold.

If the income is qualified dividend income and the child has little or no other income, the federal income tax may be zero: the first layer may be sheltered by the dependent standard deduction, and the next layer may be taxed at the child’s 0% qualified dividend and long-term capital gain rate.

The ETF choice matters. High-turnover funds, high-yield funds, bond funds, and funds with large capital gain distributions can use up the child’s annual window quickly. Low-turnover ETFs are often better suited for this type of planning because they tend to minimize taxable distributions.

Layer Two: Annual Gain Harvesting

The second part of the strategy is annual gain harvesting.

The custodian intentionally sells appreciated ETF shares owned by the child, realizes long-term capital gain, and reinvests the proceeds. The goal is to use whatever room remains below the kiddie-tax threshold after dividends and other unearned income are counted.

For example, if the child’s ETF produces $1,000 of qualified dividends during the year, roughly $1,700 of room remains before the child’s total unearned income reaches $2,700.

The custodian could sell appreciated ETF shares and realize up to about $1,700 of long-term capital gain, then reinvest the proceeds.

This is not a legal step-up in basis like the step-up that can occur at death. But economically, it can have a similar effect over time: the child recognizes gain now, potentially at little or no federal tax cost, and repurchases at a higher cost basis.

Repeating this year after year can materially reduce embedded gains in the child’s account.

Basis Tracking Matters

The basis point is important.

A gift of appreciated property generally does not give the child a fresh fair-market-value basis. For appreciated gifted property, the child usually takes the donor’s adjusted basis, with possible adjustments for gift tax paid.

That is why basis tracking and annual gain harvesting can be valuable. If the child receives appreciated ETF shares with a low carryover basis, future gains are already built into the account.

Annual gain harvesting gives the family a way to chip away at that embedded gain over time.

Harvesting gains is also different from harvesting losses. The wash-sale rule primarily disallows certain losses when substantially identical securities are acquired around the loss sale window. Recognizing a gain and buying back the asset is not the same wash-sale problem.

A Simple Example

In this example, the child has $1,500 of qualified dividends plus $1,200 of long-term capital gain, for total unearned income of $2,700.

The family has intentionally used the child’s annual window without crossing into the layer where the parents’ rate generally applies.

If the same pattern is repeated for 10 years, the child may have added $12,000 of basis. With multiple children, longer time horizons, lower-yield ETFs, or larger unused thresholds, the cumulative benefit can become meaningful.

Why This Is Especially Attractive for Business Owners

Business owners often have irregular income, high marginal tax years, estate-planning concerns, and children they already intend to support financially.

Gifting investment assets to children can move future income and appreciation out of the parents’ estate while allowing the family to use the child’s annual low-tax window.

For 2026, the federal annual gift tax exclusion is $19,000 per donor, per recipient.

A donor generally must file Form 709 if gifts to at least one person exceed the annual exclusion amount or if certain other gift-tax filing triggers apply. A gift tax return does not necessarily mean gift tax is owed, but the reporting should be handled correctly.

Implementation Checklist

This strategy needs coordination. Before transferring assets, the family should review the structure, tax reporting, investment selection, and long-term control issues.

1. Coordinate with the family’s CPA, estate-planning attorney, and investment advisor. This should be planned before transfers are made.
2. Choose the ownership structure. Options may include a UTMA/UGMA custodial account, trust, or another child-owned structure. Each has different control, tax, and age-of-access implications.
3. Use tax-efficient assets when possible. Low-turnover equity ETFs are often better fits than high-yield funds or actively managed mutual funds with unpredictable distributions.
4. Track basis carefully. Keep records of the donor’s basis, fair market value on the gift date, gift date, and any gift-tax reporting.
5. Monitor total unearned income each year. Dividends, interest, capital gain distributions, and harvested gains all count toward the threshold.
6. Harvest gains intentionally. Preferably use long-term holdings, and stop before crossing the family’s chosen tax target.
7. File the proper tax forms. The child may need a return, Form 8615, Form 8814, or the parent may need Form 709 depending on the facts. Do not assume the parent election is always better.

Important Cautions

This strategy is useful, but it is not free of complications.

• The asset belongs to the child. A custodial account is not the parent’s extra brokerage account with the child’s Social Security number attached.
• Control matters. UTMA and UGMA accounts may give the child control at a certain age depending on state law.
• Financial aid may be affected. Child-owned assets may be treated differently than parent-owned assets for education-aid purposes.
• State income tax rules may differ. This article focuses primarily on federal tax concepts.
• The parent election on Form 8814 is limited. It can be useful in narrow cases, but it generally applies only when the child has interest, ordinary dividends, and capital gain distributions. It is not a substitute for reporting the child’s actual sales of ETF shares.
• Capital gain distributions can surprise you. Large year-end fund capital gain distributions can unexpectedly use the child’s threshold. ETFs can help, but no investment is distribution-free forever.
• Other taxes and filing requirements can apply. If the child’s income becomes high enough, other taxes, filing requirements, and net investment income tax issues can arise.

The Takeaway

The kiddie tax does not prevent all family income shifting. It limits how much unearned income can be shifted before the parents’ rate comes back into play.

For business-owner families, the planning sweet spot is simple: gift assets thoughtfully, use tax-efficient ETFs, keep annual dividends and realized gains within the target window when possible, and use annual gain harvesting to raise the child’s basis over time.

Used carefully, this can move wealth to the next generation, reduce future embedded capital gains, and make good use of a child’s low-tax bracket.

It is not aggressive tax magic. It is disciplined, annual tax hygiene — and with multiple children and long time horizons, it can add up.