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How Tax Reform Affects the Kiddie Tax

Kiddie Tax

Some parents and grandparents make gifts to their kids and grandkids in an effort to reduce income taxes. This strategy shifts income into a child’s or grandchild’s lower tax bracket while also removing assets from a parent’s or grandparent’s taxable estate.

But the tax benefits of this strategy are limited due to what’s often referred to as the “kiddie tax.” Recognizing that many wealthy families were using gifting to shift large amounts of income-producing assets to children and grandchildren, Congress passed legislation in 1986 that established a threshold above which a minor’s unearned income is taxed at the parent’s marginal rate.

In 2015, the IRS collected about $1 billion in kiddie tax from approximately 343,000 families, according to the most recent IRS statistics.

Impact of Tax Reform Act

The Tax Cuts and Jobs Act that was passed last December makes some important changes to the kiddie tax that you should be aware of if you utilize gifting as a tax-reduction strategy. But first, a little background on the details of how the kiddie tax works.

The kiddie tax applies to gifts made to a child or grandchild who is under 19 years old, or under 24 years old if he or she is a full-time college student. The first $1,050 of this child’s unearned income (such as dividends, interest and capital gains) is tax free, while the next $1,050 is taxed at the child’s marginal rate.

Here’s where tax reform changed the rules. Previously, a child’s unearned income above $2,100 was taxed at the parent’s or grandparent’s marginal rate, which topped out at 39.6% before tax reform. Now, a child’s unearned income above this threshold is taxed at trust and estate tax rates.

For 2018, these rates are as follows:

Unearned Income Trust and Estate Tax Rate
Up to $2,550 10%
$2,551-$9,150 24%
$9,151-$12,500 35%
Over $12,500 37%

An example helps illustrate the potential impact of the kiddie tax. Let’s say you want to gift your son shares of stock that have appreciated in value by $10,000. The first $1,050 of the capital gain would be tax free, while the next $1,050 would be taxed at your son’s marginal rate. The rest (or $7,900) would be taxed at the trust and estate tax rate of 24%.

A Higher or Lower Tax?

The question, of course, is will your kiddie tax be higher or lower under the new rules? The answer depends on a couple of factors, including how much of your child’s unearned income is above the $2,100 threshold and what your marginal tax bracket is.

Using the numbers from the example above, the kiddie tax will now be $1,896 (7,900 x .24 = 1,896). Now let’s assume that you’re married and file a joint tax return and your adjust gross income (AGI) this year will be $150,000, which will place you in the 22% tax bracket. Under the old rules, the kiddie tax would have been a little bit less, or $1,738 (7,900 x .22 = 1,738).

Now let’s assume the stock only appreciated by $4,000 instead of $10,000. In this scenario, the unearned income above the threshold is $1,900 and the kiddie tax would be $190 (1,900 x .10 = 190). Under the old rules, it would have been more than double this, or $418 (1,900 x .22 = 418).

Complex Details Require Expert Assistance

As you can see, the details with regard to gifting as a strategy to reduce income taxes can get quite complex when the kiddie tax is factored in. Therefore, you should speak with a tax professional about your specific situation.

Please contact us if you have more questions about how the kiddie tax could affect your gifting strategies.


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