Although the so-called “kiddie tax” will be easier to calculate thanks to the Tax Cuts and Jobs Act (TCJA) of 2017, the unearned income of eligible children (or grandchildren) could be taxed at a higher rate.
For tax years 2018 through 2025, the TCJA has changed the kiddie tax taxable structure. Unearned income is now taxed at the rates paid by trusts and estates. The highest bracket of the trust/estate rates for ordinary unearned income is 37 percent (or as high as 20 percent for long-term capital gains and dividends). Before the TCJA, the kiddie tax was taxed at the parent’s marginal tax rate. With the lowering of individual tax rates for 2018, this change to the kiddie tax could have significant tax consequences for children who derive more than half of their support from unearned income.
Earned income is defined as compensation from a job or self-employment, which is not subject to the kiddie tax. Unearned income is income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. Unearned income subject to the kiddie tax may include capital gains, dividends, and interest — typically received through trusts and estates.
Under the TCJA, the IRS provides these eligibility requirements to determine if unearned income is subject to the kiddie tax:
1. The child does not file a joint return;
2. One or both of the child’s parents are alive at year-end;
3. The child’s net unearned income exceeds the threshold for that year and the child has positive taxable income after subtracting any applicable deductions (i.e., standard deduction). The unearned income threshold for 2018 is $2,100.
If the unearned income threshold is not exceeded, the kiddie tax does not apply. If the threshold is exceeded, only unearned income in excess of the threshold is applicable to the kiddie tax.
The kiddie tax can apply until the year during which the child turns age 24. For ages 19-23 at year-end, the kiddie tax can only apply if the child is a student. A child age 18 or under at year-end is almost always subject to the kiddie tax if meeting the above requirements. These age rules can be tricky, so it’s important to consult with your CPA on whether your child or grandchild is subject to this tax.
The following tax rates will be used to calculate the kiddie tax for 2018 through 2025:
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2018 Trust and Estate Tax Rates for Ordinary Income
10% tax rate $0-$2,550 = 10% of taxable income
24% tax rate $2,551-$9,151 = $255 plus 24% of the excess over $2,550
35% tax rate $9,151-$12,501 = $1,839 plus 35% of the excess over $9,150
37% tax rate $12,501+ = $3,011.50 plus 37% of the excess over
2018 Trust and Estate Tax Rates for Long-Term Capital Gains and Dividends
• 0% tax rate $0-$2,600
• 15% tax rate $2,601-$12,700
• 20% tax rate $12,701+
One final note: Due to the tax rate change, the kiddie tax is also subject to the Net Investment Income Tax if the child has undistributed net investment income and adjusted gross income is over the dollar amount at which the highest tax bracket for a trust begins. For 2018, this threshold is $12,501. The tax rate for the Net Investment Income tax is 3.8 percent for 2018.
If your child (or grandchild) derived more than half of his or her support from unearned income sources for 2018 and meets the eligibility requirements, contact the tax team at Hall Kistler with your questions.