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

If you sit in a high federal tax bracket and your child sits in a low one, you can lower the family’s combined tax bill by moving income or income-producing assets to the child. The cleanest way to shift income to your child in a lower tax bracket is to pay them real wages through a family business, because earned income escapes the Kiddie Tax that neutralizes most other moves. Everything else — custodial accounts, 529 plans, trusts, outright gifts — works around the edges of that core strategy, each with its own ceiling.

The Kiddie Tax Caps Most Asset Shifting

Congress built the Kiddie Tax to stop parents from parking investments in a child’s name and collecting the returns at the child’s rate. It hits unearned income only: dividends, interest, capital gains, and trust distributions. Wages from an actual job are untouched.

For 2026, a child’s unearned income falls into three tiers:

That third tier is why dumping a large brokerage account into your eight-year-old’s name produces no savings on anything beyond the first $2,700 of yearly income. The rule applies to children under 18, 18-year-olds whose earned income didn’t cover more than half their own support, and full-time students between 19 and 23 under the same support test. Affected families compute the tax 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 as you read the rest. Earned-income strategies clear it. Asset-transfer strategies work only up to it.

Put Your Child on the Family Business Payroll

If you own a business, hiring your child converts your high-bracket income into their low-bracket income and generates a business deduction at the same time. You pay wages. The business deducts them at your marginal rate. The child uses their own standard deduction to shelter the income.

A dependent’s 2026 standard deduction equals the greater of $1,350 or 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 gets a standard deduction of $15,050 or the single-filer cap, whichever is less, so little or none of the wages faces federal income tax.

Payroll Tax Exemptions for Children

The savings run deeper than income tax. Wages paid by a sole proprietorship, or by a partnership in which both partners are the child’s parents, to a child under 18 are exempt from Social Security and Medicare taxes. That removes 6.2% Social Security and 1.45% Medicare on both sides of the paycheck, a combined 15.3% savings per dollar. Federal unemployment tax drops out too for a child under 21 in the same qualifying structures.4Internal Revenue Service. Family Employees

These exemptions do not apply if the business is a corporation or if the partnership includes any non-parent partner. The entity structure matters as much as the family relationship.

Make the Employment Real

This is where families get sloppy, and it is exactly where the IRS looks. The child has to do actual work the business genuinely needs, and the pay has to match what the work is worth. A 12-year-old stuffing envelopes for $50 an hour will not survive scrutiny.

Keep the records you would keep for any employee: a written job description, time logs, a W-2 at year-end. If the child cleans the office, handles filing, or runs social media, document the hours and the rate the way you would for a stranger. The IRS does not object to employing family; it objects to allowances disguised as payroll.

Where the Child’s Money Should Go

Once the child has earned income, several accounts amplify the shift.

Roth IRA

A working child can contribute to a Roth IRA up to $7,500 or 100% of earned income for 2026, 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 genuinely earned at least that much. Contributions go in after tax, growth is tax-free, and qualified withdrawals in retirement are tax-free. Money placed in a Roth for a teenager has 50 or more years to compound without further tax.

529 College Savings Plan

A 529 plan sidesteps the Kiddie Tax entirely because growth inside the account is never taxed as long as the money pays qualified education expenses.6Internal Revenue Service. 529 Plans, Questions and Answers Higher-education qualified expenses include tuition, fees, books, and room and board. Starting in 2026, the annual K-12 limit rose to $20,000 per beneficiary across all of that beneficiary’s 529 accounts, and the expanded K-12 category now 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 roll into the beneficiary’s Roth IRA if the 529 has been open at least 15 years, the transferred amount came from contributions made at least five years before the rollover, and the annual rollover stays within the Roth contribution limit. A $35,000 lifetime cap applies per beneficiary.8Office of the Law Revision Counsel. 26 U.S.C. 529 – Qualified Tuition Programs Overfunding is far less risky than it used to be.

UGMA and UTMA Custodial Accounts

A Uniform Gifts to Minors Act or Uniform Transfers to Minors Act account lets you transfer assets irrevocably to the child, with an adult managing them until the child reaches the age of majority, which varies by state but generally falls between 18 and 21.9HelpWithMyBank.gov. Uniform Gifts to Minors Account (UGMA) or Uniform Transfers to Minors Act (UTMA) Income inside the account runs through the Kiddie Tax tiers, so the benefit is modest and the cap is real.

One trap catches families off guard. On the FAFSA, custodial accounts show up as the child’s asset, not the parent’s, and student assets reduce aid eligibility more sharply than parent assets. If college aid is in the picture, weigh that cost before loading up a custodial account.

Trusts When You Want More Control

Trusts hold assets for a child under terms you design, but the tax price is steep. Income retained inside a trust is taxed at the trust’s compressed brackets, which hit 37% at just $16,000 of taxable income for 2026.10Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 A single individual doesn’t reach 37% until income passes $640,600. Holding income inside a trust for “control” can produce a worse tax outcome than leaving it in the parent’s name.

Section 2503(c) Minor’s Trust

This trust is designed so that gifts into it still qualify for the annual gift tax exclusion. The trade-off is strict: principal and accumulated income must become available to the child at age 21, and if the child dies before 21, the assets must pass to the child’s estate or be subject to a general power of appointment.11Office of the Law Revision Counsel. 26 U.S.C. 2503 – Taxable Gifts12eCFR. 26 CFR 25.2503-4 – Transfer for the Benefit of a Minor Distributions trigger the Kiddie Tax on unearned income above $2,700. The structure works for families comfortable with a 21-year-old gaining full access.

Crummey Trust

A Crummey trust avoids the forced-distribution-at-21 rule by giving the beneficiary a temporary withdrawal right each time a contribution comes in. That right converts the gift into a present interest, which qualifies it for the annual exclusion. The beneficiary rarely exercises the right in practice, and the assets stay invested under the trust’s terms. Retained income still faces the compressed trust brackets, and distributions to the child still pass through the Kiddie Tax. Setting one up calls for professional legal and tax guidance.

Gift Tax Limits on Every Transfer

Every move of assets to a child — into a custodial account, trust, or 529 — is a gift. For 2026, each donor can give up to $19,000 per recipient per year with no gift tax return and no use of lifetime exemption.13Internal Revenue Service. Gifts and Inheritances FAQs

Married couples can double it. If both spouses agree, a gift from one spouse can be treated as made equally from both, bringing the per-recipient total to $38,000. Gift splitting requires filing Form 709 even when no tax is owed, and both spouses must consent to split all gifts for the year. Any gift above the annual exclusion also triggers a Form 709, though no tax is due until the donor crosses the lifetime exemption, which sits at $15,000,000 for 2026.14Internal Revenue Service. What’s New, Estate and Gift Tax

Where the IRS Draws the Line

Income shifting is legal when done properly. The IRS applies the assignment of income doctrine to stop taxpayers from simply redirecting income they earned to someone else. Income is taxed to whoever earned it or controls the asset that produced it, no matter who receives the cash. Divert business profits to a child who does no real work and the IRS will tax the profits to you anyway, often with penalties attached.

On the family-employment side, two things get examined: whether the work is genuine and whether the pay is reasonable. Paying a teenager $60,000 a year to answer the phone a few hours a week fails both tests. Benchmark against what you would pay an unrelated person for the same work in your area; that is the ceiling. Overpaying a child risks having the excess reclassified as a nondeductible gift and tends to draw attention to the rest of the return.

On the asset-transfer side, the gift has to be genuine and irrevocable. Keep trading stock in a child’s UGMA as if it were yours, or retain the power to pull trust assets back, and the IRS will treat the income as still yours. Ownership and control have to actually move.

State rules can differ. Not every state conforms to the federal provisions here, and some have their own Kiddie Tax variants or distinct treatment of trust income. A tax professional familiar with your state is worth the cost before you set any of this up.