The Kiddie Tax: What to Know About the Kiddie Tax – In 1986, a law prohibiting parents from converting investments to their children’s names in order to avoid paying taxes was passed. Previously, children’s assets were taxed at the child’s low rate, and some wealthier parents would pass investments to their children to lower their tax bill—the law, known as the “kiddie tax,” altered the rules. Most investment income for children under the age of 14 was taxed at the parent’s rate under the first statute, which reduced the value of transfers. Since then, the laws have been changed several times.
“The kiddie levy, which was enacted in 1986 to discourage parents from escaping taxes by giving their children large gifts of stock and other investments, has seen a flurry of reforms in recent years,” says Chris Manderfield, executive vice president of KeyBank.
Since then, the tax-free age for children has risen, and new laws took effect in 2018 and will be updated again in 2020. “The reach of who is subject to the tax has expanded over time, and it can now refer to dependents up to the age of 18 and college students aged 19 to 23,” says Sarah Shannonhouse, manager of tax practice and ethics at the American Institute of CPAs.
What Is the Kiddie Tax?
The “kiddie levy” is a tax on children’s unearned profits. “If the child’s unearned income exceeds $2,200, the kiddie tax kicks in,” says Michael Trank, a CPA and personal finance specialist with Wertz & Company LLP in Irvine, California. The child’s unearned income comes from sources other than employment. According to Trank, unearned income can be obtained from inherited IRAs and taxable scholarships, as well as investment income from a custodial account.
Unearned income above $2,200, as well as the child’s investment and other unearned income, are subject to the kiddie tax laws and are taxed at the parent’s rate. Any earnings from jobs taxed at the child’s status are not subject to the kiddie levy.
How Is the Kiddie Tax Calculated?
Under the kiddie tax rules for 2020, the child’s unearned income under $1,100 is not taxable; the next $1,100 is taxed at the child’s rate, and any unearned income above $2,200 is taxed at the parent’s rate.
“Either the child or the parent may choose to have their child’s interest, ordinary dividends, and capital gains distributions declared on their tax return. In this case, the income would be levied at the parent’s marginal tax rate, according to Manderfield.
When a Child Needs to File a Separate Tax Return
The guidelines for filing a separate tax return are dependent on the amount of money the child gained from working and the amount of money they earned from savings.
Children who earned more than $12,400 in earned and unearned income must file tax returns in 2020. If the child’s only income source is less than $11,000 in interest, dividends, or capital gains distributions, the parents will claim the child’s earnings on their tax return by filing Form 8814. Other requirements, according to Trank, include the child having no withholdings or planned tax prepayments, being under the age of 19 to 24 if a full-time student is not filing a joint return with a partner, and being under the age of 19 or 24 if a full-time student is not filing a joint return with a partner.
There are advantages and disadvantages to reporting the child’s income on the parent’s tax return if the child is qualified. “The advantage is convenience,” says Trank, “but there are disadvantages, such as potentially exposing the child’s income to the net investment income tax, the loss of the child’s itemized deductions, and a small increase in tax.” On capital gains and dividends that are eligible.”
More details can be found in IRS Topic 553, Tax on a Child’s Investment and Other Unearned Money, as well as IRS Publication 929, Tax Laws for Children and Dependents.
Redoing 2018 and 2019 Kiddie Tax Returns
The laws governing children’s taxes were temporarily changed in 2018 and 2019. Under the Tax Cuts and Jobs Act, the kiddie tax was based on the tax rates that apply to estates and trusts rather than the child’s parent’s tax rate. According to Shannonhouse, “as a consequence, from 2018 to 2019, dependents subject to kiddie tax laws could have potentially been taxed at rates higher than their parent’s marginal tax rate.”
At the end of 2019, new legislation was passed that reverted the child tax rate to that of the parents. Parents who paid the estate tax rate in 2018 and 2019 will move to the parent rate on their income tax returns. “Taxpayers should measure the kiddie tax using either the estate tax rates or the parents’ tax rate for 2018 and 2019 returns,” Shannonhouse recommends. “Beginning in 2020, the parent’s tax rate will be applied.”
You have three years from the due date of your tax return to make adjustments. “When determining whether or not to amend, the parents should compare the results and determine whether the benefit is appropriate to warrant the time and expense,” Trank suggests. “If the parents are in the middle or lower tax brackets, amending could save them money.”