In December 2017, Congress enacted the Tax Cuts and Jobs Act (“TCJA”) and changed how your children were taxed by the IRS on their investment-type income. These TCJA changes led to much higher tax bills for minor children and college-age dependents.
Congress recently passed the SECURE Act (Setting Every Community Up for Retirement Enhancement) and President Trump signed it into law on December 20, 2019 (Pub. L. 116-94). The new law repeals the kiddie tax changes from the TCJA and takes you back to the old kiddie tax rules, even retroactively if you so desire.
Kiddie Tax Basics
When your kids are subject to the kiddie tax, it forces them to pay taxes at a higher rate than the rate they would normally pay at their income level. Here’s the key: the kiddie tax does not apply to all of a child’s income, only to his or her “unearned” income, which means income from:
- capital gains,
- inherited IRA distributions,
- profit interests from passive activities (for the child), such as a share of S corporation profits, and
- any type of income other than compensation for work.
For 2019, your child pays the kiddie tax only on unearned income above $2,100. For example, if your child has $3,000 of unearned income, $900 would be subject to these extra taxes.
Who Pays the Kiddie Tax?
The kiddie tax applies to children with more than $2,100 of unearned income (see above) when the children:
- have to file a tax return,
- do not file a joint tax return,
- have at least one living parent at the end of the year,
- are under age 18 at the end of the year,
- are age 18 at the end of the year and did not have earned income that was more than half of their support, or
- are full-time students over age 18 and under age 24 at the end of the year who did not have earned income that was more than half of their support.
Calculating the Kiddie Tax
Under the TCJA, now valid only for tax years 2018 and 2019, any income subject to the kiddie tax is taxed at estate and trust tax rates, which reach a monstrous 37 percent with only $12,070 of income in tax year 2019. Yikes! That’s a high tax rate on just a little income.
Under the old rules, before the TCJA, your child would have had to have paid tax at your tax rate on income subject to the kiddie tax, not at the estate and trust rates.
Kiddie Tax Choices
The SECURE Act repeals the TCJA kiddie tax rules for tax years 2020 and forward and returns the tax calculation to the pre-TCJA calculation that uses your tax rate. And here’s even better news for 2019 filings; the new law also gives you the option to calculate the kiddie tax using your tax rate for tax years 2018, 2019, or both—it’s your choice. Essentially, if your kids are affected by the kiddie tax, you can opt out of the estate and trust tax rates for 2019.
If you would like to discuss the kiddie tax and how it may impact your tax filings, please call our office at (724) 731-0150.