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Tribal Gaming Revenue Distributions Subject to the 'Kiddie Tax'

August 07, 2017

Congress enacted the so-called "Kiddie Tax" in 1986 to keep wealthy parents from saving taxes by way of gifting income producing property to children in lower brackets. Recently released ILM 201729001, a new IRS legal memo, shows how this rule can apply in situations having nothing to do with family tax planning.

Details of the Tax
The Kiddie Tax, as designed under Internal Revenue Code Sec. 1(g), taxes "unearned" income of children at their parent's tax rate if it exceeds a threshold amount, which is $2,100 in 2017. Unearned income below that amount is taxed at the child's rate. This tax is computed on Form 8615

While dividends and interest are the classic sources of unearned income, the Kiddie Tax has a broader reach, as ILM 201729001 illustrates. The memo involves payments made under the Indian Gaming Regulatory Act, which allows tribes to distribute gambling revenues per capita to members, including children. These distributions aren't legally interest or dividends. But are they "unearned?"

Defining 'Unearned'
The Kiddie Tax rules get their definition of "unearned" income from Section 911, the provision that allows taxpayers living abroad to exclude income "earned" overseas from U.S. income tax. It says, any income that isn't "earned" under Sec. 911(d)(2) is unearned. 

To be "earned" under Sec. 911, according to the IRS legal memo, income has to be "wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered." The tribal distributions fail to meet this rule, according to the memo (emphasis added):

A member of Tribe who is a child (as defined is § 1(g)(2)) does not receive the per capita payments of gaming revenues of $x per year under Tribe's revenue allocation plan as compensation for personal services rendered or actually rendered under § 911(d)(2)(A) or (B). Rather, a member of Tribe who is a child receives the per capita payment of $x per year due to his or her status as a member of Tribe, without regard to whether he or she renders personal services

Therefore, Tribe's per capita payments of Tribe's gaming revenues made pursuant to its revenue allocation plan paid to or on behalf of a child (as defined in § 1(g)(2)) who is a member of Tribe are not earned income of that child 

A Reminder
The IRS legal memo reminds us that children can pay taxes at their parents' tax rates on a lot more items of unearned income than just dividends or interest. In addition to the tribal payments covered in the memo, "unearned" income can also include, among other things, payments made from a deceased parent's retirement account to a child. It's also important to note that if the child is a full-time student, the Kiddie Tax can apply until age 24. The Kiddie Tax cannot be avoided by the parent simply failing to claim the child as a dependent, as the tax applies as long as the child's "earned" income is less than one-half of the child's total "support."

Contact an Eide Bailly tax professional to learn more about income tax planning for children and other dependents.