How do custodial accounts use Tax-Gain Harvesting to realize tax-free gains?

Tax-Gain Harvesting (not to be confused with Tax-Loss Harvesting) is a feature we offer for our UGMA/UTMA custodial accounts. It enables beneficiaries—while they qualify under the Kiddie Tax rules as minors or students over 18—to step up their investments’ cost basis federal-tax-free, thereby potentially reducing their future tax burden.

The “Kiddie Tax”

Under IRS rules for 2026, most children’s unearned income (dividends, interest, capital gains) is federally taxed as follows:

• First $1,350: Free of federal tax, assuming the child has no earned income. 
• Next $1,350 (up to $2,700): Taxed at the child’s individual rate—usually 10% for ordinary income, and 0% for long-term capital gains.
• Above $2,700: Taxed at the parents’ marginal rate, which is usually higher.

Note: The IRS updates these thresholds regularly. Children who earn wages may have a different standard deduction. State and local tax thresholds may be lower than federal thresholds. Learn more.

How Tax-Gain Harvesting could lower your child’s future taxes

These rules mean that many children can realize up to $2,700 in long-term capital gains completely free of federal tax. This benefit enables us to use Tax-Gain Harvesting to potentially reduce your child’s future tax burden:

1. Each December, we look at how much your child’s custodial account has earned in the current year. Earnings include interest, dividends and net realized gains and losses.
2. We subtract that number from the harvesting limit you’ve selected (in your account’s Tax Optimization setting on the Manage page). 
3. The difference is the amount your child could still earn federal-tax-free or tax-advantaged. We sell shares to maximize available gains up to that difference, and then reinvest the proceeds.

The result is that your child’s investments now have a higher cost basis. This potentially reduces their future capital gains taxes while incurring no federal taxes (or lower federal taxes) in the present.

Note: While we will do our best not to exceed your harvesting limit, we may go over it in some cases—for example, if dividends arrive very late in the year. It’s also likely that we don’t harvest gains right up to the limit you set. We will typically leave some “buffer” to avoid unexpectedly going over the limit.

Should I enable Tax-Gain Harvesting in my child’s account?

Tax-Gain Harvesting can be a great move for many custodians—a powerful way to reduce your child’s future federal tax burden. However, this limit applies to the child, not just to one account, so if your child has significant unearned income outside of their Wealthfront custodial account, you may want to disable this feature or reduce the harvesting limit.

Example 1: Child has no other unearned income. Let’s suppose you want to maximize federal-tax-free gains for your child. Because they can receive $1,350 in federal-tax-free unearned income annually, you leave the annual harvesting limit at $1,350. Over the course of the year, their custodial account earns $50 in dividends. At the end of December, we sell enough of your child’s assets to realize $1,300 in gains, and use the proceeds to buy similar assets. 

Result: your child’s assets are left with a higher cost basis, reducing their future federal taxes owed. No federal tax is owed this year, because the sum of their $50 in dividends and $1,300 in realized gains is $1,350. You have maximized the federal-tax-free gains available to your child for the year.

Example 2: Child does have other unearned income. This is the same as the scenario above, except this time, your child earns $50 in dividends from the account you manage and $100 in dividends from a brokerage account created for them by another relative. Because you don’t want to exceed the $1,350 federal-tax-free threshold, you adjust the annual harvesting limit to $1,250. This time, at the end of December, we sell enough of your child’s assets to realize just $1,200 in gains. 

This achieves the same result as example 1—maximizing gains without paying federal taxes. It avoids overshooting the tax threshold by accounting for the $100 in outside dividends.

In fact, if their account balance or other income are high enough, you may want to turn on Tax-Loss Harvesting instead.

Can I use Tax-Loss Harvesting for my custodial account instead?

Yes, though it’s usually not the right choice for custodial accounts. Tax-Loss Harvesting might be a good idea if:

• The beneficiary has unearned income (e.g., dividends or interest) in excess of $2,700.
• The beneficiary earns taxable income (e.g. wages) that can be offset by tax losses.

You can find more information on whether Tax-Loss Harvesting is right for your custodial account by going to your custodial account’s Manage page and selecting “Tax optimization.”

How do I enable Tax-Gain Harvesting?

It’s enabled by default for custodial accounts, with a default annual harvesting limit set to the standard deduction for unearned income (currently $1,350 for most states). You can modify or disable it in your custodial account’s manage page by selecting “Tax optimization”.

Will Wealthfront always harvest up to $1,350 of gains each year?

The amount of gains harvested each year depends on factors such as available gains in the account, dividends, and the account’s harvesting limit. The default limit for most states is set to the IRS threshold for federal-tax-free unearned income for children (currently $1,350). In a small number of states (HI, IN, MO), the default is set to less than $1,350 to help avoid creating additional state tax filing requirements. The default limit for OH and PA accounts is also $1,350, but using this feature may cause the child to have to file a state tax return in these states regardless of the harvesting limit due to their low thresholds. Clients in all states and territories can set their custodial account’s harvesting limit to anywhere between $1 and $2,700, or disable Tax-Gain Harvesting entirely, depending on their child’s tax situation.