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It’s one of those bad news/good news things. The Tax Cuts and Jobs Act (the Act) changed the kiddie tax rates for a child’s unearned income, from the parents’ marginal rate to the highly compressed rates applicable to trusts. That’s the bad news.

The good news is that the basic structure of the kiddie tax didn’t change significantly and, for some families, the tax rate change actually reduces the amount of the tax.

Introduction to the Kiddie Tax

The original kiddie tax was intended to discourage the shifting of income from affluent parents to children, thus reducing the family’s overall income tax bill. Under the kiddie tax, the unearned income of dependent children that meet age requirements and certain other criteria is taxed differently.

The rules changed over the years — for example, including older children. But the basic concept remained the same: For these children, their net unearned income over a specified minimum amount was taxable at their parents’ marginal tax rate.

Tax reform changed the rules again — at least through 2025.

Earned Income vs. Unearned Income

Earned income refers to wages, salaries, fees for professional services and self-employment. In other words, it’s what your child is paid for work.

Unearned income is everything else, including interest, dividends, capital gains, rents and royalties, as well as pension and annuity income (including from inherited retirement accounts, such as traditional IRAs and 401(k) plans), taxable legal settlements, taxable Social Security benefits, alimony, unemployment compensation and certain taxable scholarship and fellowship grants.

Kiddie Tax Rate for Unearned Income

The Act changed the kiddie tax rate for a child’s net unearned income from the parents’ marginal tax rate to the applicable rate established for trusts.

The primary impact of this change is in the brackets: The trust tax rates are highly compressed, meaning that each bracket starts at a much lower income level. In other words, the same amount of income is generally subject to higher tax rates for trusts than for individuals (single or married).

For example, the top trust rate of 37 percent applies to ordinary income starting at $12,501. By contrast, the 37 percent bracket for individuals doesn’t start until income exceeds $500,000. The top trust tax rate of 20 percent for qualified dividends and capital gins applies to income starting at $12,701 while the 20 percent bracket for individuals doesn’t start until income exceeds $425,800.

Federal Income Tax Rate Trust Income Brackets Individual Income Brackets (Single)
Ordinary Income
10% $0 – $2,550 $0 to $9,525
12% N/A $9,526 to $38,700
22% N/A $38,701 to $82,500
24% $2,551 – $9, 150 $82,501 to $157,500
32% N/A $157,501 to $200,000
35% $9,151 – $12,500 $200,001 to $500,000
37% $12, 501 + $500,001 +
Qualified Dividends
and Capital Gains
0% $0 – $2,600 $0 to 38,600
15% $2,601 – $12,700 $38,601 to $425,800
20% $12,701 + $425,801 +

 

Families Impacted by the Kiddie Tax

Children must meet certain age requirements before they are potentially subject to the kiddie tax. In general, the tax applies to children who are under the age of 18 as of the end of the tax year.

It also applies to children who are 18 at year-end but have unearned income that is less than or equal to the total amount of their support (excluding scholarships).

Finally, for children 19 – 23 at year-end, it applies if they are full-time students for at least five months during the year, and have unearned income that is less than or equal to the total amount of their support (excluding scholarships)

Assuming your child meets the age requirement, the kiddie tax applies to the child’s unearned income if the child:

bullet graphic: green arrow  has unearned income that exceeds the unearned income threshold amount ($2,100 for 2018, indexed for inflation)

bullet graphic: green arrow   has at least one parent living as of the end of the tax year

bullet graphic: green arrow  is required to file a tax return for the tax year, and

bullet graphic: green arrow  if married, does not file a joint return.

Calculating the Kiddie Tax

It can be a bit complicated, but very generally the kiddie tax is calculated as follows:

The amount of your child’s taxable income is equal to total income (earned and unearned) less the standard deduction. For kiddie tax purposes, the first $1,050 of unearned income is tax-free.

The typical $12,000 standard deduction is limited to the greater of $1,050 or earned income plus $350.

In calculating the tax on this income, the earned taxable income portion is subject to federal income tax at the rates for single individuals.

Net unearned income in excess of the $2,100 threshold amount is subject to tax at the rates for trusts.

The total tax due is the sum of the tax on earned taxable income and the tax on net unearned income.

Strategies to Minimize the Impact of the Kiddie Tax

If your tax strategy involves shifting income to your children, it’s important to analyze the impact of the compressed trust rates on your family’s tax strategy — including both parents’ and children’s tax liabilities, withholdings and/or estimated payments.

Perhaps counterintuitively, for some high-income families, the change to using trust tax rates may actually reduce the kiddie tax. For others, it increases the tax. Because the impact of the kiddie tax on each family is unique, it is critical to plan ahead.

There are a number of strategies you can consider to minimize the impact of the kiddie tax overall, including the following:

bullet graphic: green arrow  Earned Income

The kiddie tax only applies to unearned income. Income earned from work in a family business or from another job is not subject to the kiddie tax.

Given the Act’s increased standard deduction through 2025, a child can potentially earn up to $12,000 from work and pay no federal income tax. Significantly, unlike unearned income, earned income can be invested in an IRA or Roth IRA account for tax-deferred growth.

bullet graphic: green arrow  An Individual Tax Return

Children may be able to generate tax savings by filing their own individual income tax returns — assuming they have sufficient assets to pass the support test and claim themselves as a dependent on their own returns. If so, your child can claim a $12,000 standard deduction and, potentially, the American Opportunity Tax Credit if in school.

bullet graphic: green arrow  Election to Report on Parent’s Return

If your child’s income consists exclusively of interest and qualified dividends — and the total is between $1,050 and $10,500 — you may be able to elect to report the income on your own tax return rather than your child’s.

The value of such an approach depends on the applicable tax rates and income, the election could reduce your family’s overall tax liability.

bullet graphic: green arrow  Tax-Free Investments

Certain investments, such as municipal bonds, earn income free of federal income tax, and therefore also free from kiddie tax.

bullet graphic: green arrow  Tax-Deferred Investments

The income from some investments (e.g., Series EE and Series I U.S. savings bonds) is tax deferred until maturity, which you could potentially schedule for after your child reaches 18 — or older if a student subject to the kiddie tax.

SEE ALSO: Want to Delay Taxes for Your Beneficiaries? Consider a Stretch-Out IRA

 

The kiddie tax is a complex area of the federal tax code. Get Great Advice.

 

 

Concerned about the impact of the kiddie tax
on your family’s finances?

Give us a call. We can help.

 

KEELEY KENNETT
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