Despite its innocuous-sounding name, the “kiddie tax” is anything but child’s play, as both taxpayers and practitioners can attest.
This unique tax law provision has been further complicated by the Tax Cuts and Jobs Act (TCJA) as how it is calculated has been modified, which is bad news for some clients and good news for others.
The kiddie tax, which was written into the tax code way back in 1986, applies to unearned income above an annual threshold received by a child under a specified age. The age has been gradually raised over the years. Currently, it applies to a dependent child under age 19 or a full-time student under age 24. Thus, the term “kiddie tax” is a bit of a misnomer.
For these purposes, “unearned income” includes income other than wages, salaries, professional fees and other amounts received as compensation for personal services. Typically, capital gains, dividends and interest income are subject to the kiddie tax. But earned income from a job or self-employment is exempt.
Prior to the TCJA, any excess was taxed at the top tax rate of the child’s parents, regardless of the source of the income. This turned into a tax headache for some families with high-income parents.
The kiddie tax threshold was $2,100 for 2017, the last year under the old rules, while the top tax rate for parents was 39.6 percent. For 2018 through 2025, the kiddie tax threshold remains at $2,100 (inflation-indexed to $2,200 for 2019) and the top tax rate has been reduced to 37 percent.
Key point: The TCJA changes the method used to figure the kiddie tax. The tax calculation is now based on the federal income tax rates in effect for estates and trusts—not the top tax rate of the parents.
Why is This a Problem?
The tax brackets for estates and trusts are more compressed than those for individuals, so the higher rates kick in sooner. Without getting into all the gory details, using these tax rates instead of the new tax rates for individuals often results in an overall kiddie tax that is higher than the tax would have applied under the old rules.
Conversely, some families may save tax under the new kiddie tax calculation, especially when there’s a small amount of excess income. Crunch the numbers for your clients.
Words of Caution
We may not have heard the end of this story. Legislation recently introduced in Congress would restore the kiddie tax calculation to the old method before 2026 rolls around. Continue to monitor developments relating to the kiddie tax.
Next week Ken Berry concludes this series, discussing the TCJA impact on business meals and beverages
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...