As you probably already knew, the kiddie tax is the attempt of the taxing authorities to prevent high income adults from shifting income to children who enjoy a lower tax rate. With the tax law overhaul at the end of 2017, a couple of changes in the rates mean higher taxes for many children for the next several years before the law sunsets in 2025.
The focus of the kiddie tax is on unearned income such as interest, dividends , capital gains and the like. This type of income is usually derived from assets which have been gifted to the child or contributed to a trust of which the child is beneficiary. Earned income is not the focus of the kiddie tax so a working child is not taxed as heavily on that income.
Prior law subjected the unearned income to a parent’s marginal tax rate where that rate was greater than the rate applicable to the child as an individual taxpayer. Under the current law, the first $2,200 of unearned income is taxed at 10% while additional unearned income is now subject to the estates and trusts rates. It is important to understand that the estates and trust tax brackets are very narrow and the applicable tax rate can increase rapidly as a result. The first $2,600 of unearned income above that $2,100 threshold for kiddie tax applicability, is taxed at 10%. However, unearned income above $2,600 and up to $9,300 is taxed at a 24% rate while the next bracket applies a 35% rate for amounts up to $12,750. Amounts above that income level are taxed at 37%. This means a much heavier tax burden is likely where there is any significant unearned income.
Other rules pertaining to the applicability of the kiddie tax – such as ages, classification as a student, and provision of support – are unchanged. If you have made significant gifts to minors resulting in unearned income to them, you will want to ensure that you are prepared for the impact of these changes since you will see them in the 2018 tax returns you are currently completing.