The Tax Cuts and Jobs Act of 2017 (TCJA) changed the kiddie tax rules. The kiddie tax rules were created by Congress in order to close a loophole in which parents in high-income tax brackets would shift their investment income to their children in lower income tax brackets.
The kiddie tax provisions under pre-Act law provided net unearned (typically interest, dividends, capital gains) income of a child was taxed at the parents’ tax rate if the parents’ tax rate was higher than the tax rates of the child. Kiddie tax applied to a child if:
For tax years beginning after December 31, 2017, the child’s standard deduction and the kiddie tax threshold still remain at $1,050, respectively, so the child would pay no tax on unearned income up to $2,100. The taxable income of a child attributable to earned income is taxed under the tax rates for single individuals, and the unearned income is taxed according to the brackets applicable to trusts and estates; the parents’ rate will no longer matter. This has a potentially large implication, as the trust and estate tax brackets are much more compressed compared to the individual brackets. For 2018 the trust and estate rates are as follows:
The taxable income brackets for trust and estates are much more compact than for individuals, with the top marginal tax rate of 37% being reached at only $12,500 for trusts compared to $600,000 on the married filing joint side. Additionally, long-term capital gains will continue to be taxed at preferential rates of 15% and 23.8%; when the net investment income exceeds $12,500.
Kiddie tax can be a huge financial burden. We have identified a few tax planning methods to reduce the burden. One method is to keep the child’s annual investment income at $2,100 or below. Another planning method involves investing in qualified dividends. Qualified dividends are taxed at the capital gains rate of either 0%, 15% or 23.8%, depending on the taxable income bracket. Pushing the investment income to a later tax year until the child turns 19 years old and are not a full-time student, or the child turns 24 years old can also help to reduce tax. Additionally, utilizing qualified tuition plans or Coverdell education savings accounts can help bypass kiddie tax.
The new kiddie tax rules may be advantageous to certain taxpayer situations. For more details on the new kiddie tax rules, or other tax planning opportunities, please contact your Withum Tax Advisor or fill out the form below and we’ll respond to you shortly.