The Tax for Certain Children Who Have Unearned Income, informally known as the Kiddie Tax, has been a hot topic in legislative circles these days. Congress altered the Kiddie Tax rules when they enacted the Tax Cuts and Jobs Act (TCJA) at the end of 2017 but reversed those changes when they passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act at the end of 2019. Having two major law changes in quick succession meant a unique opportunity for taxpayers: the freedom of choice. For tax years 2018 and 2019, taxpayers can elect the rules that best suit them and their tax position. Beginning in 2020, all calculations will revert to pre-TCJA Kiddie Tax rules.
Kiddie Tax Refresher
Children age 19 and younger who report more than $2,200 of unearned income (e.g., interest, dividends, capital gains) will be subject to Kiddie Tax. Individuals between the ages of 19 and 23 may also be subject to Kiddie Tax if (1) they are full-time students, and (2) their earned income (like wages from a job) does not exceed half the cost of their annual support.
What Changed with the TCJA
For decades, Kiddie Tax was assessed at parents’ highest marginal tax rates, but when Congress passed the TCJA in 2017, things changed. The new TCJA law decreed that for an eight-year period beginning in 2018, children’s unearned income was taxed progressively using the tax tables for trusts and estates. This meant that the first $2,600 of Kiddie-taxable income would be taxed at 10%, the next $6,700 would be taxed at 24%, and so on. Many taxpayers (but not all) were better off under the TCJA-era Kiddie Tax rules using the trust and estate rates. The progressive rate tables for trusts and estates often produced a smaller tax burden than if the parents’ marginal tax rate was applied as a flat tax across the board.
2019 Ordinary Income Tax Rates
Individual - Married Filing Jointly
Trusts & Estates
|10%||$0 to $19,400||10%||$0 to $2,600|
|12%||$19,401 to $78,950|
|22%||$78,951 to $168,400|
|24%||$168,401 to $321,450||24%||$2,601 to $9,300|
|32%||$321,451 to $408,200|
|35%||$408,201 to $612,350||35%||$9,301 to $12,750|
|37%||$612,351 +||37%||$12,751 +|
Another benefit of the TCJA-era Kiddie Tax rule was the ease of determining the tax rate. Taxpayers simply look to the trust and estate tables for determination of the tax rate. Pre-TCJA, both parents’ marginal tax rates were relevant to the calculation, so parents that filed separate returns had a nasty calculation ahead of them. And when parents had more than one child subject to Kiddie Tax, their calculation only got more complex. The TCJA-era rules eliminated these obstacles and simplified the Kiddie Tax computation by looking to the trust and estates rates.
What Changed with the SECURE Act
The SECURE Act reverted Kiddie Tax calculations to pre-TCJA law, which uses the parents’ highest marginal tax rates. The impetus behind the change was how the TCJA-era law affected Gold Star families.
Gold Star families are the spouses and children of veterans who died while serving in the military. These families were often eligible for survivor benefits from both the Department of Defense (DOD) and the Department of Veterans Affairs (VA), but because of a decades-old rule against “double dipping,” they could not accept both. The benefits they received from the DOD would offset benefits received from the VA, and vice versa. To circumvent this penalty, surviving spouses would often transfer DOD benefits to their children.
But by shifting survivor benefits to their children, the Gold Star family unit’s Kiddie Tax liabilities shot through the roof. These benefits were so generous that children’s unearned income was being taxed at the maximum marginal trust and estate tax rate of 37%.
While Gold Star families often preferred pre-TCJA rules, other families preferred TCJA-era rules. The SECURE Act decided on a compromise. The Act did not immediately revoke the TCJA-era rules, but it gave taxpayers the option to select the calculation method that worked best for them in tax years 2018 and 2019. Beginning in 2020, all calculations will revert to pre-TCJA Kiddie Tax rules so that Kiddie Tax will be assessed using parents’ marginal tax rates.
How to Proceed
Taxpayers can file their 2018 and 2019 returns using whichever method they desire, and if they need to amend their returns to do so, they can do so freely. To elect non-TCJA Kiddie Tax calculations, taxpayers must simply attach a statement to their return stating their election. If you have further questions about Kiddie Tax or would like to discuss your options with one of our CPAs, contact us today.