Many of us have seen our tax brackets decrease as a result of the Tax Cuts and Jobs Act (TCJA) of 2017. However, some taxpayers will see their taxes increase under the Act. Among that group are children subject to the “kiddie tax.”
The kiddie tax still applies to the same category of taxpayers – those with unearned income under age 19 and full-time students under age 24. Historically, the kiddie tax subjected children’s unearned income over $2,100 to the parents’ rate. The idea was to keep parents from transferring assets to their kids’ names to take advantage of lower tax rates.
But now under the TCJA, the unearned income over $2,100 is not taxed at the parents’ rate but at the much higher rate of a trust. For example, trust income (and now income subject to kiddie tax) reaches the top 37% bracket at just $12,500 of taxable income, whereas a married couple filing jointly would not reach this level until $600,000…
Let’s say 14-year-old Junior has unearned income of $12,100 from investments in a custodial account that his family set up to save for college. His parents file jointly and have $120,000 of income. Under the old tax law, his parents were in the 25% bracket, but now under the TCJA, they will be in the 22% bracket. Unfortunately, Junior doesn’t benefit from the rate decrease. Last year, $10,000 of his income ($12,100 minus the $2,100 threshold) would have been taxed at his parents’ 25% rate. Now in 2018, it will be taxed at trust rates, and Junior will be in the 35% bracket.
On the other hand, if the funds had been invested in a 529 college savings plan, the income would grow tax-deferred and not be subject to tax at all if used for qualified educational expenses. Also keep in mind that the kiddie tax applies only to unearned income, not to earned income like wages from a summer job.
As a result of the TCJA, families will want to take stock of what investments are in their children’s names and could be subject to kiddie tax. If you have kids with significant investment income (or if you’re considering opening a custodial account for them), consult your financial advisor first. He or she can help you weigh the advantages and disadvantages of different types of accounts and recommend an investment mix to align with your goals and tax strategy.