In December 2017, Congress enacted the Tax Cuts and Jobs Act (TCJA) and changed how your children calculate their tax on their investment-type income. The TCJA changes led to much higher tax bills for many children.
On December 19, 2019, Congress passed a bill that the president signed 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 children are subject to the kiddie tax, it forces them to pay taxes at a higher rate than the rate they would usually pay.
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,
- S corporation distributions, 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, only $900 is subject to the extra taxes.
WHO PAYS THE KIDDIE TAX?
The kiddie tax applies to children with more than $2,100 of unearned income 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.
Under the old rules before the TCJA, your child paid tax at your tax rate on income subject to the kiddie tax.
KIDDIE TAX CHOICES
The SECURE Act, which the president signed into law on December 20, 2019, 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.
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 is your choice.
In order to realize the benefits of these tax planning strategies, there are tax compliance requirements which must be designed and implemented in advance as well as maintained throughout the year.