The “Kiddie Tax” Has Grown
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Our “Kiddie Tax” Has Grown Up

4/4/2018 | By: David N. Milner, Esq. | GDB 2018 Spring Newsletter
While many provisions of the recently enacted Tax Cuts and Jobs Act (TCJA) received wide spread publicity, several provisions received little attention in the press. Among these were the changes made to the “Kiddie Tax” provisions of the Internal Revenue Code.

What is the “Kiddie Tax”?

In order to avoid parents and grandpar­ents transferring investments to their children/grandchildren with the expecta­tion that the income would be taxed at lower rates, many years ago Congress im­posed a Kiddie Tax, which required that the investment income of children be taxed at the same tax rates as their parents.

The new Kiddie Tax rules, which take ef­fect this year, change the method of taxing a child’s investment income. Under the new rules, investment income will be taxed using the tax brackets applicable to trust and estates regardless of the rate at which the child’s parents pay tax. While the maxi­mum rate of 37% applies to both trusts and estates and individuals, for trusts and estates the brackets are compressed.

For example, under the new Kiddie Tax rules, a 37% rate will apply to ordinary net unearned taxable income in excess of $12,500. By comparison, a single individual who is not subject to the Kiddie Tax having the same income will be taxed at the12% marginal tax bracket. Much the same is true for long term capital gains and qualified dividends. Under the Kiddie Tax regime, long term capital gains and qualified dividends will be subject to a 20% tax if taxable income exceeds $12,700, while those not subject to the Kiddie Tax will not reach the 20% bracket until taxable income exceeds $425,800.

The new Kiddie Tax rules will apply if:
  • The child does not file a joint return with their spouse, and
  • At least one of the child’s parents are alive, and
  • The child has positive taxable income after subtracting any applicable deduc­tions, and
  • The child’s unearned income (interest, dividends, other investment income and capital gains) exceeds the threshold amount for the tax year (for 2018 the threshold is $2,100), and either
    • The child is 17 or younger at the end of the tax year, or
    • The child is 18 at the end of the tax year and does not have earned income that exceeds half of their support, or
    •  The child is 19 to 23 at the end of the tax year and (a) is a full-time student for at least 5 months during the taxable year and (b) does not have earned in­come that exceeds half of their support.
The new Kiddie Tax rules only apply to investment income. The child’s earned income (i.e. wages) will be taxed at the child’s regular tax rate; however, the child’s applicable deductions will be applied to first offset earned income before offset­ting any investment income subject to the potentially higher Kiddie Tax rates.

Effect of the New Rates

It is now entirely possible for investment income received by a child to be taxed at a greater rate than had the income been received by their parent or grandparent.

For example, assume a 16 year old has in­vestment income of $22,100 in 2018, has no earned income and that his or her par­ents have taxable income of $275,000 and file a joint income tax return. The child’s tax on his net unearned income of $20,000 ($22,100 less the annual threshold amount of $2,100) using the income tax brackets applicable to trusts and estates will be $5,786.50. Had this investment income been received by their parents, effectively increasing their taxable income to $297,100, the investment income would have been taxed at their marginal income rate of 24%, yielding additional income tax of $5,304.00. As applied to this family, the Kiddie Tax rules result in there being an additional tax cost to the family of $482.50.

While there very well may be many reasons to make gifts of investment income property to children and grandchildren, the impact of these new rules should be considered.