Unearned income and tax implications for children’s certificates of deposit

Opening a certificate of deposit (CD) for your child can be a great way to help them build savings and earn a guaranteed return. What many parents don’t realize, though, is that the interest a child’s CD earns can also create tax obligations.

The interest earned on a child’s CD counts as unearned income, income generated from investments rather than work. Depending on how much unearned income your child has, it could be subject to special IRS kiddie tax rules. Those rules can affect how the income is taxed and who reports it on a tax return.

Fortunately, tax rules for minors with unearned income aren’t as complicated as they seem. In this guide, we’ll explain how children’s CD interest is taxed, when your child may need to file a tax return, how the kiddie tax works, and what you can do to avoid unexpected surprises come tax time.

What is unearned income for a child?

Unearned income is money your child receives from investments instead of from working. This can include interest from a savings account or CD, stock dividends, capital gains from selling investments, and certain trust distributions.

By comparison, earned income comes from a job. Wages, salaries, tips, and money earned through self-employment all count as earned income.

Here’s a simple breakdown to make the difference clearer:

Earned income vs. unearned income examples

Interest earned on a child’s certificate of deposit is considered unearned income, no matter how old the child is. If the CD earns more than $10 in interest during the year, the bank or credit union will generally issue a Form 1099-INT reporting that income under your child’s Social Security number (SSN).

The kiddie tax: Three-tier structure explained

The kiddie tax is an IRS rule meant to stop parents from shifting investment income into a child’s name just to lower taxes.

Here’s how the tax is generally structured based on a child’s unearned income:

The key number is $2,700. If a child’s unearned income stays under that amount, the tax impact is usually small. Once it goes over that line, part of the income can be taxed at the parent’s higher rate, which is where things get more expensive.

The kiddie tax generally applies to children under 18. It can also apply to 18-year-olds with low earned income and full-time students aged 19 to 23 who do not provide more than half of their own support.

There are also exceptions. A married child filing jointly or a child who provides more than half of their own support through earned income is usually not subject to these rules.

Real-world tax calculation examples

Here’s how the kiddie tax plays out in real life using simple examples and 2026 tax rates from the IRS.

Example 1: Minimal tax impact

A 10-year-old earns $500 in CD interest.

• Total unearned income: $500
• Taxable income: $0
• Federal tax owed: $0
  

Takeaway: Small CD balances typically do not create any tax bill.

Example 2: Moderate tax impact

A 12-year-old earns $2,000 in CD interest.

• First $1,350: tax-free (Tier 1)
• Next $650: taxed at the child’s 10% rate (Tier 2)
• Tax: $650 × 10% = $65
• Federal tax owed: $65
  

Takeaway: Staying within the first two tiers keeps taxes low and simple.

Example 3: Parent-rate taxation kicks in

A 15-year-old earns $5,000 in CD interest. Assume the child’s parents are in the 24% tax bracket.

• First $1,350: $0 tax
  
• Next $1,350: $1,350 taxed at 10% = $135
  
• Remaining $2,300: taxed at 24% = $552
  
• Total federal tax: $687
  

Takeaway: Once income goes over $2,700, part of it gets taxed at the parent’s rate, which can cause the tax bill to increase significantly.

This last example shows why tax planning matters so much. Keeping a child’s CD interest under $2,700 can help avoid higher taxes and keep things simple.

Tax minimization strategies for parents

Here are a few ways parents can manage taxes on a child’s CD interest without overcomplicating things.

1. Threshold management

With this strategy, you would keep annual interest under $2,700 to avoid higher parent-rate taxation under the kiddie tax rules.

Here’s a quick way to think about it:

At a 4.5% APY, $60,000 in principal generates roughly $2,700 in interest. Use that estimate only as a planning reference because the actual interest earned depends on the CD’s compounding method and term. Also, remember the money placed in a custodial account legally belongs to the child. Moving money among children’s accounts solely to reduce taxes could create gift, ownership, and fairness considerations.

2. Form 8814 election

Parents may be able to report a child’s interest and dividend income on their own return using Form 8814 if all IRS eligibility requirements are met, including the applicable income limit. For the 2025 form currently available, the child’s gross income must be less than $13,500 and consist only of interest and dividends, including capital gains distributions.

This can simplify the filing process, but it also raises your adjusted gross income. It may also remove the child’s lower tax bracket advantage.

3. Alternative account types

Another college savings option is a 529 college savings plan. These accounts allow tax-free growth when used for qualified education expenses, which can be more efficient than taxable CDs in some cases.

Some states also offer additional benefits for contributions made to 529 plans, including tax deductions or credits.

A 529 plan is not a direct substitute for a custodial CD because the ownership, permitted uses, investment risk, and financial aid treatment differ. Compare those features before moving money intended for a child.

Common mistakes and how to avoid them

A few small mistakes can turn a simple CD into a tax headache. Here are the big ones to watch for.

1. SSN confusion

Some parents accidentally use their own Social Security number instead of their child’s on a custodial CD.

Fix: Double-check that the account uses the child’s SSN. If it’s wrong, call the bank right away to update it.

2. Failing to file

It’s a common myth that minors never file taxes. That’s not true.

Fix: A child may need to file a return when unearned income exceeds $1,350, even if the child is young. Missing a required return can lead to penalties and interest.

3. Ignoring financial aid impact

Large custodial accounts can affect college aid because assets owned by the student may receive different treatment from parent-owned assets in financial aid calculations.

Fix: Understand how each account may affect financial aid before choosing where to save. Custodial assets can generally be used for the child’s benefit beyond education expenses, while tax-free 529 withdrawals are limited to qualified education expenses.

4. Incorrect Form 8615 calculations

Kiddie tax reporting can get tricky, and it’s important to make sure everything submitted is correct.

Fix: Use tax software or a tax professional if you’re unsure.

5. Missing better options

Some parents open custodial CDs without looking at 529 plans or Coverdell education savings accounts (ESAs), which may offer better tax treatment for education savings.

Fix: Consider all the different ways you could be saving for your child’s future, as well as the pros and cons of each.

Helping your child save without tax surprises

CD interest earned by children counts as unearned income and may be subject to the kiddie tax. Once income goes over $2,700, the child’s net unearned income above the applicable threshold may be taxed using the parent’s marginal rate.

To stay compliant, make sure the CD uses the child’s SSN, required tax returns are filed on time, and Form 8615 is completed correctly when needed.

Next, review your child’s current CD balances, estimate annual interest, and gather any tax documents you’ll need. From there, you can decide if it makes sense to make changes based on savings and tax-planning goals.

If you’re unsure, talking with a tax professional can help you avoid costly mistakes. These rules can feel detailed, but once you understand the basics, it becomes much easier to manage a child’s savings tax-efficiently.

Frequently asked questions