Years ago, some parents and grandparents attempted to save tax by putting investments in the names of their children or grandchildren in lower income tax brackets. To discourage this behavior, congress created the “kiddie tax” in 1986. Learn more about what the kiddie tax is, and then learn how the kiddie tax has changed for 2018, courtesy of Pasquesi Sheppard LLC, located in the greater Chicago area.
What Is Kiddie Tax?
As mentioned, the kiddie tax is a special tax law aimed at discouraging parents or grandparents from taking advantage of a loophole, in which parents or grandparents bestow large amounts of stock on their children or grandchildren.
Kiddie Tax: A Short History
Years ago, the kiddie tax applied only to children under the age 14 — which still provided families with ample opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and full-time students under age 24 (unless the students provide more than half of their own support from earned income).
What about the kiddie tax rate? Before the Tax Cuts and Jobs Act (TCJA), for children subject to the kiddie tax, any unearned income beyond a certain amount ($2,100 for 2017) was taxed at their parents’ marginal rate (assuming it was higher), rather than their own likely low rate. But for 2018, kiddie tax operates differently. Learn the new kiddie tax rules below.
Kiddie Tax Rules: A Fiercer Tax
The TCJA doesn’t further expand who’s subject to the kiddie tax. But it will effectively increase the kiddie tax rate in many cases.
The rules for 2018 – 2015 are as follows:
- A child’s unearned income beyond the threshold ($2,100 again for 2018) will be taxed according to the tax brackets used for trusts and estates.
- For ordinary 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.
By contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2018 taxable income tops $600,000.
Similarly, the 15% long-term capital gains rate takes effect at $77,201 for joint filers but at only $2,601 for trusts and estates. And the 20% rate kicks in at $479,001 and $12,701, respectively.
In other words, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income. As a result, income shifting to children subject to the kiddie tax will not only not save tax, but it could actually increase a family’s overall tax liability.
Kiddie Tax and the Moral of the Story
To avoid increasing your family’s taxes inadvertently, be sure to consider the big, bad kiddie tax before transferring income-producing or highly appreciated assets to a child or grandchild who’s a minor or college student. Since the kiddie tax has changed for 2018, now — more than ever — should you heed our expert advice.
If you have adult children or grandchildren who are no longer subject to the kiddie tax and who are in a lower tax bracket, you can shift income and transfer assets to them.
Contact Our Lake Forest CPA Firm for Tax Questions!
If you have any questions about the kiddie tax in particular, how the TCJA has affected other areas of the tax code, or any tax-related questions whatsoever, do not hesitate to contact our Chicagoland CPA firm. Contact us by completing this secure form. We’ll respond to your queries or messages promptly.