Once upon a time, parents and grandparents tried to save tax by putting investments in the names of their young children or grandchildren who are in lower income tax brackets. To discourage such tactics, Congress created the “kiddie” tax back in 1986. Now, because of the new Tax Cuts and Jobs Act (TCJA), the kiddie tax has steadily become more far-reaching and more dangerous than ever.
A short history
Years ago, the kiddie tax was only applicable to children under age 14, which still allowed families enough chance to enjoy substantial tax savings from transferring income to their children. In 2006, the tax extended to children under age 18. Since 2008, the kiddie tax has applied to minors up to full-time students under age 24 (unless the students earn over half of their support).
What about the kiddie tax rate? Before the TCJA, children subject to the kiddie tax who received any unearned income beyond $2,100 for 2017 were taxed at their parents’ marginal rate (believing it was higher), rather than their likely low rate.
A fiercer kiddie tax
The TCJA doesn’t further expand who’s subject to the kiddie tax, but it will successfully increase the kiddie tax rate in multiple situations.
Through 2018 to 2025, the tax brackets used for trusts and estates will be used to tax a child’s unearned income beyond $2,100 for 2018. For regular income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2018 taxable income exceeds $12,500. In contrast, a married couple filing jointly won’t have to worry until their 2018 taxable income tops $600,000 because the highest rate doesn’t kick in until then.
Likewise, for joint filers, the 15% long-term capital gains rate takes effect at $77,201, but only $2,601 for estates and trusts; and the 20% rate begins at $479,001 and $12,701, respectively.
In other words, in most cases, a child’s unearned income will be taxed at higher rates than their parents’ income. As a result, shifting income to children who are subject to the kiddie tax will not only not save tax, but it could increase a family’s overall tax liability.
The moral of the story
To avoid unintentionally increasing your family’s taxes, consider the awful kiddie tax before shifting highly appreciated or income-producing assets to a child or grandchild who’s a minor or college student. If you’d like to shift income and you have adult children or grandchildren who aren’t subject to the kiddie tax and in a lower tax bracket, consider moving such assets to them.
If you have any questions about the kiddie tax or other TCJA changes that may affect your family, contact us.
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Ben R Shull CPA LLC provides clients with tax, transaction, and advisory services. The insights and quality services we deliver help lead our clients through the next generation of changes, and accelerate growth while reducing risk. CPA Katy, TX.