Rethink transferring funds due to the “kiddie tax”
The ”kiddie tax” was first enacted by Congress as a means to keep parents or grandparents in high tax brackets from shielding their income by giving it to children within their family in lower tax brackets. Although this tax was a bit of a headache for some in prior years, it has since evolved due to the Tax Cuts and Jobs Act (TCJA) restructuring the tax rate.
The beginning of the tax
When the kiddie tax was first brought into play, it only applied to children under 14. This allowed families to take advantage of older children and have large tax savings. The age grew to children under 18 in 2006 and has now been applied to children under 19 and full-time students under 24 since 2008. The exception to students is if they earn more than half of their own income.
Children who fell under the kiddie tax rate were taxed at their parents’ marginal rate for any unearned income, such as from dividends, capital gains, or interest. Since the TCJA, although the ages that are applicable to the kiddie tax will remain the same as they’ve been since 2008, the rate has increased drastically.
If a child has an unearned income over the threshold amount during 2018-2025, it will be taxed with the same tax bracket for trusts and estates. The threshold amount may vary by tax year ($2,100 for 2018, $2,200 for 2019), so it is important to do the proper research. If a child has an earned income, the kiddie tax doesn’t apply to those wages.
Trust and estates are taxed at the highest marginal rate of 37% once the income from interest or short-term capital gains surpasses $12,750 for 2019. For a joint-filing married couple, the highest rate doesn’t come into effect until their 2019 income goes over $612,350. Long-term capital gains are taxed at 15% once the income exceeds $2,650 for trusts and estates, as opposed to $78,750 for joint filers in 2019. The 20% rate is applied at $12,950 and $488,850, respectively.
According to these rates, a child’s unearned income could quite easily be taxed at a higher rate than their parents’. Transferring income to a child could actually cost a family more in taxes rather than giving the family a tax break.
Rising tax bills for Gold Star families
Another change that was brought about by the TCJA is that children from Gold Star military families have the kiddie tax applied to them on some benefits they receive from the Defense Department. In certain cases, this has led to a tripling of tax bills because under current law these benefits are treated as unearned income. The U.S. Senate passed a bill to have the benefits treated as an earned income, but the accompanying bill from the U.S. House of Representatives is stalled at the moment.
Planning for the future
If you’re thinking about shifting your income to your child or grandchild, you could be increasing your family’s taxes rather than receiving a tax break. You could transfer those funds to an adult child or grandchild who is in a lower tax bracket and doesn’t have the kiddie tax applied to them. If children in your family already have an unearned income that is higher than the threshold, contact us for possible solutions and plans for reducing the kiddie tax for the future.