In today’s day and age we all strive to make sure our children are better off then we were. To that end, we often see children with investment accounts which, in the past, also sometimes provided a way to shelter some income at lower tax brackets. The last great tax reform, 1986, addressed this issue and brought us the kiddie tax. Under these rules, children are taxed at their normal applicable rates on their earned income, and on their investment income up to a prescribed amount.
Under the prior law, children who had more than the prescribed amount of unearned income for the tax year would be taxed as though the income was earned by their parents at their rate. These rulings tried to eliminate parents and grandparents from moving large amounts of investment income from their own high tax rates to the low rates of the children. This seems like it covered the issue and solved the problem. So what did the current reform have to say about that?
Effective for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Tax Cut and Jobs Act modifies the kiddie tax to effectively apply the estates’ and trusts’ ordinary and capital gains rates to the unearned income of a child that exceeds the prescribed amount. The kiddie tax rules apply to the income of any child who:
(a) is under age 18, regardless of whether his or her earned income equals more than one-half of his support; or (b) turns 18, or if a full-time student turns 19-23, before the end of the applicable year, and the child’s earned income for the tax year doesn’t exceed one-half of his or her support
has at least one living parent at the close of the tax year
doesn’t file a joint return for the tax year,
has over a prescribed amount of unearned income during the tax year
Although this does help simplify the tax preparation as the parents return does not need to be completed in conjunction with the child’s return, it does often mean more taxes. the trust rates are much more condensed and reach the highest marginal rate of 37% at just $12,500 in income compared to the individual rate not reaching the 37% bracket at between $500,000 and $600,000. So what does that all mean for the average taxpayer? Assume that the child has $14,000 of unearned income in 2018 and that the parents have taxable income of $150,000. In 2017, the parents’ marginal rate would have been 25%, so the tax on the $14,000 would have been $3,500. If the old rules still applied in 2018, the parents’ rate would be 22%, which would result in an $3,080 tax on the $14,000 of income. In 2018, using the trust rates, the tax would be $3,567. Lower-income families could easily be hit harder by the law change than higher-income families. Under pre-TCJA law, lower-income families who paid the kiddie tax often paid it at a low rate (the low-income parents’ rate) but will likely pay that tax under the TCJA at a high trust/estate tax rate.
Unfortunately, with all changes there are winners and losers. Let us help review your tax positions and help you plan to use the new law to be a winner. Let our team at RPB help you.
Brad Voght is the tax partner at Reilly, Penner & Benton, LLP, a public accounting firm and trusted adviser specializing in business and personal tax matters as well as in not-for-profit work, school organizations as well as government and municipal agency work. The firm also provides ERISA audit services to publicly held entities throughout the country. A PCAOB registered firm, Reilly, Penner & Benton CPAs also known as RPB CPAs, has served closely held businesses and has provided tax preparation and advice, financial statement audits, reviews and compilations, employee benefit plan audits, bookkeeping services, business valuations, fraud prevention and consulting services since 1907.