On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017 (“TCJA”). The TCJA is the largest tax overhaul since the 1986 Tax Reform Act and it will affect almost every individual and business in the United States. Generally, the new law went into effect in 2018, with many of the provisions relating to individuals expiring at the end of 2025. In contrast, a majority of the provisions relating to businesses are made permanent.
One of the changes the TCJA made was to so the so-called “Kiddie Tax”. Under the TCJA, the “allocable parental tax” (i.e. the “Kiddie Tax” which is the additional taxes a child pays based on adding their unearned or investment income to their parents’ top marginal tax rates) is restructured. Instead of adding this type of the child’s passive income to their parents’ tax brackets, for tax years beginning after Dec. 31, 2017, the taxable income of a child attributable to net unearned income (i.e. investment income) in excess of $2,100 is taxed according to the brackets applicable to trusts and estates – which, as noted below, have a top tax bracket of 37% on any income over $12,500. Here are the trusts and estates rates for 2018:
|37%||$12,501 or more|
Notwithstanding the foregoing, the taxable income of a child attributable to earned income is still taxed under the rates for single individuals. While it might appear that the new tax rate structure for a child’s investment income that tops out at $12,500 will trigger significantly larger tax bills than in the past, it may in fact end up saving taxes depending on the parents’ tax bracket.
For example, consider a situation where a child receives $5,000 of income subject to the kiddie tax and her parents have taxable income of $150,000. Based on the previous law, the parents’ tax rate of 22% would be applied to the $5,000 resulting in $1,100 of tax. However, under the revised Kiddie Tax rules which apply the trust tax rates, the new law produces a Kiddie Tax bill of just $843 on the child’s investment income.