The end of the 'Kiddie Tax' could save families thousands in taxes.
The SECURE Act includes some far-reaching changes to retirement, but also a relatively innocuous-looking change that can make a big difference to parents of kids with unearned income. This change is embodied in the ‘Kiddie Tax’. Prior to the Tax Cuts and Jobs Act (TCJA), children with unearned income had received the first $1,100 of unearned income tax-free, and the next $1,100 was taxed at the child’s rate. Earnings over $2,200 were taxed at the parent’s rate. TCJA changed that rate to the trust income tax rates, which could be much higher than the parent’s rate and created a draconian penalty on a child’s unearned income. Cohen & Company’s Jonathan Williamson, CPA, MT, notes, “Certain unearned income of children has long been taxed at rates outside of said child’s tax bracket, a provision more commonly known as the ‘kiddie tax’. This rule is in place to curb parents from pushing certain types of income into lower tax rates of their children.”
The change created some unintended, and rather unwelcome, consequences. Williamson writes, “The TCJA altered the applicable tax rates on this type of income from the parent’s tax rate to the tax rates applied to trusts and estates. Each dollar amount of the income bracket for estates and trusts is much smaller, and the maximum tax rate is reached at a lower income level, when compared to the brackets and tax rates for individuals.” To address this issue, SECURE reverted the taxation on this type of income to the tax rates of the parents for tax years beginning after 2019, with the option to use the new rates for 2019 and amend 2018.”
Here's a look at the current numbers: For 2020, a dependent child’s standard deductions is the greater of $1,100 or the sum of $350 plus the child’s earned income, if the child can be claimed as a dependent. Here is a comparison of the 2020 rates for trusts and a married couple:
The difference between the Trust Tax Rate and the Married Filing Joint Rate
The SECURE Act repeals the TCJA change in the Kiddie tax and is effective for 2020 and beyond. There is the option to apply the rules to 2019 tax returns and amend 2018. Laura Springer, Senior Manager of Private Client Services at Sequoia Financial Group, likes that the changes are retroactive: “The TCJA glitch caused a lot of concern for families with children with unearned income. This fix is retroactive for 2019 and 2018 returns, so this will help parents on filing their 2019 return as well.”