You’ve probably heard this statement written by Benjamin Franklin in 1789: “In this world, nothing can be said to be certain, except death and taxes.” Well, even taxes aren’t totally certain because Congress changes the tax code periodically. The Kiddie Tax was created in the 1986 Tax Reform Act and Congress made significant changes to the tax code again in 2017 with the creation of the “Tax Cuts and Jobs Act.”
The Original Kiddie Tax
The element of the tax code referred-to as the “Kiddie Tax” was designed to prevent parents and grandparents in high tax brackets from avoiding tax payments on high producing investment assets by transferring them to their children who are typically in lower income tax brackets.
What Are the Kiddie Tax Changes?
Under the new tax code rules, the Kiddie Tax can apply until the year that a child turns 24 when the following requirements are met during a specific tax year:
- The child does not file a joint tax return.
- One or both child’s parents are alive at the end of the tax year.
- The child’s net unearned income for the year exceeds the income filing threshold for that year, and the child has positive taxable income. (The Kiddie Tax does not apply to any salary or wages, which are taxed at normal rates.)
“Unearned income” includes income-producing assets acquired by the child or a parent/grandparent on behalf of the child, such as capital gains, income from rents or royalties, annuity income, and trust income.
What are the Beneficial Changes to the Kiddie Tax?
Under the new tax code rules, three important changes take effect, benefitting children who have modest unearned income.
- The child’s unearned income is no longer added to the parents’ income to arrive at the income tax rate.
- A child’s unearned income above $2,100 is taxed at the “Trust & Estate Tax Rate” which can be lower than a parent’s higher tax rate and lower than some long-term capital gains and dividends rates.
- For homes with multiple children, the income for each child is taxed on that individual, instead of being aggregated to the parents, as with prior tax codes.
How Can You Avoid Paying the Kiddie Tax?
First, simply keep any investment income attributed to a child at $2,100 or less. That can also be accomplished by investing in instruments which appreciate over time but don’t generate current income.
Second, invest in a 529 plan, where investments can grow tax-free and withdrawals are also tax free if they are used for qualified education expenses for the beneficiary.
Seek Expert Financial Assistance
Contact Estess CPAs, based out of New Orleans, LA and serving the greater New Orleans area for all your tax and accounting needs. Don’t navigate the complicated tax rules alone. Estess CPAs specializes in serving the needs of small businesses with professional accounting, bookkeeping, tax planning, and payroll services.