What’s New Kiddie Tax?

July 2, 2018 | Article

As part of the Tax Reform Act of 1986, the “Kiddie tax,” a taxing regime designed to make the transfer of income items by wealthy parents to lower tax paying children less attractive, was implemented. However, the Tax Cuts and Jobs Act (TCJA) made a change to the tax intended to make the calculation of the Kiddie tax simpler. But the question is, what other things come along with the new simplification?

Kiddie tax simplification comes by the way the unearned income of a child is taxed. Under the rules prior to the TCJA, the unearned income of a child was taxed at the highest marginal tax rate of the parent. This method of taxing the child’s unearned income produced certain difficulties in application, particularly if the parent extended their return, or if the child did not have access to the parent’s tax rate information.

Under the new rules of the TCJA, the child’s unearned income for years after 2017 and before 2026 will be taxed using the tax brackets and rates applied to trusts and estates. This would also be true for any capital transactions.

It does appear to be a simpler calculation, but with the drop in individual tax brackets and the lowering of individual tax rates by the TCJA, using the trust and estate brackets and rates, which impose a 37 percent tax rate on income over $12,500, creates the potential for the child to pay a higher tax than under the prior law.

The Kiddie tax applies to any child that

  1. has not reached the age of 18 by the end of the taxable year, or
  2. has not reached the age of 24, is a full-time student and has earned income less than one-half of their support level.

While there is opportunity for reducing a child’s unearned income through various tax planning measures, each situation will be unique, requiring specific calculations of tax to be completed.

In addition, there may be an advantage to restructuring the source of the child’s unearned income stream, or to establish formal trust arrangements, which are now less onerous than under prior law since the tax rates used for calculating tax on unearned income of the child will match those of the trust. Plus, in certain cases, increasing earned income of the child to over one-half the child’s support level may be the best choice, as it would have the ability to completely eliminate the child from Kiddie tax consideration.

The takeaway is that every child with unearned income exceeding $12,500 in 2018 should have their taxable income position reviewed to determine if there is an opportunity to reduce, or eliminate, the resulting Kiddie tax, even if it is a simplified version of the tax.

If you would like to have more information on the Kiddie tax, please contact an Eide Bailly tax professional.

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