Posted by Schneiderman and Friedman

An Insight into the Kiddie Tax

An Insight into the Kiddie Tax

Before the Kiddie tax, parents could get tax savings by setting up an investment account using the kid's name. Parents could give various items like a stock to their kids in which the income on the investment would enjoy a lower (the child's) income tax rate, not the higher (parent's) income tax rate. 

With the kiddie tax, parents can no longer take this opportunity as such investments are taxed at higher rates. 

Kiddie Tax: A Brief History 

The idea behind the kiddie tax was to prevent parents from setting up assets that will produce income for their kids in their name and enjoy a lower tax rate. With the Kiddie tax, taxes of all unearned income above a specific limit happens at the parent's tax rate, not the child. 

There was a slight adjustment to this rule from the TCJA of 2017, which was affected in 2018. It no longer used the parent's tax rate but the estates and trusts tax rate, which made the kiddie tax pretty expensive for a couple of families. This did not go down well with many taxpayers due to the impact on scholarships. 

In response, Congress made a provision in the SECURE Act to revert this tax to the old rule. As a result, in 2019, the maiden $1,100 of the child's unearned income can enjoy the standard deduction method while the next $1,100 is subjected to the kid's income tax. Revenue more than $2,200 will be subjected to the income tax rate of the parent. 

Mode of Operation of the Kiddie Tax 

Every dependent kid below 19 years or full-time kids between 19 and 23 years is subjected to the kiddie tax. However, a child whose total earned income is above half of their support costs is an exception to the rule. Also, kids that file tax as married and jointly is an exception. 

The kiddie tax does not apply to income from wages, tips, self-employment, salaries, etc. Some of the unearned revenues of a child are:

  • Dividends

  • Taxable interest

  • Taxable scholarship

  • Income from gifts coming from grandkids

Calculating the Kiddie tax 

The first step to calculate the kiddie tax is to ascertain the taxable income of a child.

Taxable income of a Child = Net Earned income of the Kid + Net Unearned Income of the Kid – the kid's standard deduction.

In 2019, the standard deduction value was whichever is more significant: a sum of $350 and the kid's earned income or $1,100, provided the kid qualifies to be claimed as a dependent. If not, a single filer will use $12,000 as the standard deduction amount. 

Families with unearned income subject to the Kiddie’s tax should file IRS form 8615 alongside their tax return. Kids with unearned income should file a fresh tax return if the value is more than $11000 or whatever the earned income amount is 

Does the 529 Plan affect the Kiddie tax?

All interest that comes from 529 plans, alongside other 529 plans (custodial accounts), are not bound by the Kiddie Tax. The 529 program aims to serve as an investment that will help people save for colleges. The contributed money is after-tax, and all earnings grow while deferring the tax. The distribution is tax-free if the funds apply to the payment of higher school and education expenses that qualify.

Other custodial accounts, however, have their investment earnings subject to Kiddie tax. It is possible to convert custodial accounts dedicated to college savings to different custodial 529 plans that allow you to benefit from the tax.



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