Updated: Dec 9, 2019
The last massive tax reform prior to the Tax Cuts and Jobs Act, (HR 1, TCJA) instituted a special tax on a child’s unearned income to prevent parents and grandparents from shifting income to their children in lower tax brackets. This special tax took on the clever name – “kiddie tax”.
Children in the following situations with unearned income above the $2,100 (for 2018) threshold must compute and pay the so-called “kiddie tax”. Examples of unearned income include interest income from bank accounts, bond interest, and ordinary dividends from stock. Essentially it is income not earned through employment, work or business activities. The tax is imposed on any unearned income regardless of the source of assets and regardless of when or who transferred those assets.
The “kiddie tax” generally applies when:
Children under the age of 19 or children aged 19-23 who are enrolled, full-time students and whose earned income is less than half of their annual expenses; and
The child did not file a joint return; and
The child has at least one living parent at the close of the tax year.
Prior to the Tax Cuts and Jobs Act (HR 1), the unearned income above the threshold would be taxed at their parent’s highest rate. In an effort to simplify the calculation, the new law (HR 1) changes the rates at which the child’s unearned income above $2,100 will be taxed. The highly, compressed rates for trusts and estates will now be used to tax the income (see below).
These new rates will generally produce a higher tax bill than the previous rates would have, although there are some instances where that is not the case. From a tax planning perspective, it is important to watch and monitor the amount of unearned income a child is earning. As the table suggests, there is a relatively large jump in tax rates once unearned income reaches $9,150.
Beyond the direct impact of the new kiddie tax rules, taxpayers should be aware that a child’s unearned income may also trigger the net investment income and alternative minimum taxes. If your child’s unearned income is likely to be taxed under the “kiddie tax” rules, it would be wise to consult your CPA for tax planning strategies.