If your family has trouble with the kiddie tax, you face some new wrinkles for tax years 2018 through 2025 thanks to the Tax Cuts and Jobs Act (TCJA) tax reform. This is one of the many areas where tax planning can pay off.
For 2018–2025, the TCJA tax reform changes the kiddie tax rules to tax a portion of an affected child’s or young adult’s unearned income at the federal income tax rates paid by trusts and estates.
Trust tax rates can be as high as 37 percent or, for long-term capital gains and qualified dividends, as high as 20 percent.
Unearned income means income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. So, among other things, unearned income includes capital gains, dividends, and interest.
Earned income from a job or self-employment is never subject to the kiddie tax.
Exploit the Unearned Income Threshold
Your dependent child or young adult faces no kiddie tax problems if he or she does not have unearned income in excess of the kiddie tax unearned income threshold ($2,100 for 2018 and $2,200 for 2019).
And when your dependent child exceeds the threshold by only a minor amount, the kiddie tax hit is minimal and nothing to get too upset about.
Planning Matters
But if your child is getting hit hard by the kiddie tax, your tax planning should consider the following:
- employing your child so that he or she has earned income sufficient to eliminate the kiddie tax, or
- changing the investment mix from income generation to capital growth.
Final Thoughts
The kiddie tax applies when all four of the following requirements are met for the tax year in question:
Requirement 1
The child (or young adult) does not file a joint return for the year.
Requirement 2
One or both of the child’s parents are alive at the end of the year.
Requirement 3
The child’s net unearned income for the year exceeds the threshold for that year and the child has positive taxable income after subtracting any applicable deductions, such as the standard deduction. The unearned income threshold for 2018 is $2,100 and $2,200 for 2019 (in later years, it’s adjusted periodically for inflation).
If the unearned income threshold is not exceeded, the kiddie tax does not apply for that year. If the threshold is exceeded, only unearned income in excess of the threshold is hit with the kiddie tax.
Requirement 4
The child falls under one of the following three kiddie tax age rules due to his or her age at yearend and the other factors mentioned below:
- Age Rule 1 (Age 17 or Younger). If the child is age 17 or younger at year-end, the kiddie tax applies if the other three requirements above are also met.
- Age Rule 2 (Age 18). If the child is age 18 at year-end and does not have earned income that exceeds half of his or her support, the kiddie tax applies if the other three requirements above are also met.
- Age Rule 3 (Age 19–23 and Student). If the child is age 19–23 at year-end and (1) is a student and (2) does not have earned income that exceeds half of his or her support, the kiddie tax applies if the other three requirements are also met. The child is considered a student if he or she attends school full time for at least five months during the year.
Some Real World Examples
Example. Your daughter is age 17 on December 31 and subject to the kiddie tax if the other three requirements above are also met.
Example. Your son is age 19 on December 31. He does not have earned income that exceeds half of his support for the year and he is a student. He falls under Age Rule 3 and is subject to the kiddie tax if the other three requirements above are also met.
Example. Your daughter is age 21 on December 31. She graduated from college in May and has traveled since. She is subject to the kiddie tax under Age Rule 3 (because she was a full-time student for the first five months of the year and has very little earned income for the year). Next year, assuming she is done with school, none of the age rules will apply and she will not be subject to the kiddie tax.
Variation. If your daughter got a job in June and had earned income in excess of half of her support for the year, Age Rule 3 would not apply and she would be exempt from the kiddie tax.
If your family is facing a kiddie tax problem, be sure to give me a call at 509-543-7600 so I can help you reduce or maybe eliminate the kiddie tax.