Big changes are happening to the kiddie tax for the years 2018-2025. The Tax Cuts & Jobs Act repealed the kiddie tax policy and replaced the tax rates applicable on dependents’ unearned income with the same rates that apply to trusts and estates. Unearned income includes taxable interest, ordinary dividends, capital gains, rents, unemployment compensation, etc. Scholarships are exempt. The new structure will be unfavorable for most children, as it causes more kids to file tax returns and likely pay more tax than ever before. In the past, income subject to kiddie tax was taxed at the parents’ marginal rate. Now, in attempt to simplify the old complex process, the parents’ rate and any siblings’ unearned income will no longer matter. Instead, investment earnings in excess of an annual amount ($2,100 for 2018) will be taxed using the compressed rate brackets below:
- Up to $2,550 10%
- $2,550 to $9,150 24%
- $9,150 to $12,500 35%
- Over $12,500 37%
To calculate the kiddie tax, a child’s net earned income is added to net unearned income, then reduced by the standard deduction amount, to arrive at taxable income. The portion of taxable income that consisted of earned income is taxed at regular single taxpayer rates, while the unearned income portion that exceeds the threshold is subject to the above trust and estate tax rates.
The kiddie tax applies when the following requirements are met:
- The child is required to file a tax return for the year
- The child does not file a joint tax return
- At least one parent is alive
- Net unearned income exceeds the annual threshold ($1,050 in 2018)
- The child has positive taxable income
- At least one of these age rules are met:
- Age 17 or under at 12/31
- Age 18 at 12/31and does not provide half their own support
- Age 19-23 full-time student and earned income does not equal half his or her support
Even if a dependent files his or her own tax return, the parent can still claim the child on their tax return, assuming the dependent did not provide over half their own support during the year. In some cases, it is more beneficial for a parent to elect to claim a dependent’s income on their tax return, as long as certain criteria are met. This would be accomplished using Form 8814 (Parents’ Election to Report Child’s Interest and Dividends). Although the kiddie tax laws were designed to discourage the shifting of income-generating assets into children’s names, these recent changes could actually have the opposite effect under some circumstances.
While the new “Kiddie Tax” is easier to calculate, it can be more expensive for children with significant unearned income. Please contact your tax professional at Ketel Thorstenson if you have tax planning questions.