The "kiddie tax": All investment income that children receive above the threshold amount is taxed at their parent's highest income tax rate. That rate could be as high as 35%, compared to the 10% rate that most children would be paying. Any unearned income below the standard deduction amount ($1,050 in 2015) is not taxed or reported to the IRS. The kiddie tax applies to children under 19 years of age & children aged 19 through 23 who are full-time students and whose earned income does not exceed half of the annual expenses for their support. To be considered a student, a child must attend school full time during at least five months of the year. It doesn't matter whether the child is claimed as a dependent on the parent's return. However, the tax does not apply to a child under 24 who is married and files a joint tax return.
To help avoid the threshold, investments can be chosen that appreciate in value over time but don't generate much or any taxable income until they're sold. These include index funds, U.S. savings bonds, municipal bonds, growth stocks (no dividends), treasury bonds, tax managed funds. If the investments are sold after the child turns 24 to sell, there's no kiddie tax; with this strategy, a child might use student loans & then pay them off by selling the investments after 24.
We opted for an irrevocable trust because it holds assets outside of our & our child's tax return & pays taxes at a much lower rate than our highest rate. It also avoids the UGMA rule of child ownership at 18, & the trust is not limited to education payouts. We did not expect to be able to qualify for FAFSA.