Consider Kiddie Tax When Planning Investments for Kids

By Steven M. Brettholtz

The Tax Cuts and Jobs Act (TCJA) simplified taxes on unearned income for children under 18 and full-time, dependent students under 24 — also known as the “Kiddie Tax.” The Kiddie Tax previously had children paying taxes on investment income at their parents’ highest tax rate. 

As of 2018, the Kiddie Tax is levied on unearned income using the same tax tables as trusts, without regard to parents’ tax rates. The first $2,100 of a child’s unearned income is untaxed. Additional income will be taxed using the trust tax tables.

It’s now easier to calculate, but kids with significant unearned income may face higher taxes. Generally speaking, higher tax rates are imposed on trusts at a lower income level than for individuals, so a child with unearned income may see an increase in their tax liability.

For example, a child with $26,000 of taxable, unearned income in 2017 paid $6,500 in tax if their parents were in a 25% tax bracket. In 2018, given the same scenario, the child would pay $8,007 because the trust tax rate for income over $12,500 is $3,011.50 plus 37% of the excess over $12,500, an increase of 23%. 

Parents and grandparents should familiarize themselves with the Kiddie Tax rates and monitor a youngster’s unearned income sources when giving additional income-producing investments or selling long-term capital assets held in the child’s name.

A grandparent considering leaving his or her IRA to a grandchild should know that a youngster subject to Kiddie Tax might face a higher tax rate than an adult inheriting the same IRA. Likewise, a grandparent might consider gifting an asset to help pay for a grandchild’s education.  The sale of the asset by the student could launch him or her into a top trust tax bracket. But the parents could potentially pay only a 15% rate if they were given the property and sold it to pay their child’s education costs.

If you have a child who is subject to the Kiddie Tax, our office can help identify strategies that may reduce the Kiddie Tax in subsequent years.

The Kiddie Tax applies if:

1. The child's unearned income was more than $2,100
2. The child meets one of the following age requirements:

• The child was under age 18 at the end of the tax year
• The child was age 18 but less than 19 at the end of the tax year and the child's earned income didn't exceed one-half of the child's own support for the year (excluding scholarships if the child was a full-time student), or
• The child was a full-time student who was at least 19 and under age 24 at the end of the tax year and the child's earned income didn't exceed one-half of the child's own support for the year (excluding scholarships)

3. At least one of the child's parents was alive at the end of the tax year
4. The child is required to file a tax return for the tax year, and
5. The child doesn't file a joint return for the tax year

Steven Brettholtz is president of Myers, Brettholtz & Company, PA. His decades of accounting experience include numerous assignments in all phases of taxation for individuals, businesses entities and non-profit organizations. He is a member of the Florida, California, Hawaii, Nevada, New York Accountancy Societies, and the American Institute of Certified Public Accountants (AICPA).