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Kiddie Tax No Longer Based on Parents' Tax Rate

Article Highlights:

  • Parents Attempting to Shift Income to Children 
  • Kiddie Tax 
  • Tax Reform Changes 
  • Tax on Child’s Unearned Income 
  • Tax on Child’s Earned Income 
Some years back, it was not uncommon for parents to put their investments in their dependent children’s names to take advantage of their children’s lower tax rates. Although the Uniform Gift to Minors Act legally made a child the owner of money put into his or her name, this didn’t stop parents from routinely putting their child’s name and social security number on the accounts so that the tax would be determined at the child’s lower marginal rate.

The IRS had no easy way to combat parents taking advantage of their children’s lower tax rates, so Congress came up with a unique way of taxing children’s investment income (unearned income) such as interest, dividends and capital gains. When this law was originally passed over 30 years ago, it only applied to children under age 14, but Congress expanded it over time to include children with unearned income under the age of 19 and full-time students under the age of 24 who aren’t self-supporting.

The way it worked prior to the 2017 tax reform, the first $1,050 of a child's income was tax-free, the next $1,050 was taxed at just 10% and any unearned income above $2,100 was taxed at his or her parents' higher tax rate. A child’s earned income (generally income from wages) was taxed at the single rate, and the child could use the regular standard deduction for single individuals ($6,350 in 2017) to reduce his or her taxable earned income. The computation got more complicated when the child’s siblings also had unearned income.

With tax reform, for years 2018 through 2025, the first $2,100 of the child’s unearned income is being taxed as before, with the first $1,050 being tax-free and the next $1,050 being taxed at 10%. However, instead of the balance being taxed at the parents’ tax rate, the balance is taxed at the income tax rates for estates and trusts, which for 2018 hits 37% when the balance of the unearned income reaches $12,500. The income tax rates for trusts and estates are illustrated below.

2018 Federal Tax Rate Schedule – Estates & Trusts
If the taxable income is: The tax is:
Over But not over Of the amount over
$0
$2,550
10%
$0
2,550
9,150
$255.00 + 24%
2,550
9,150
12,500
1,839.00 + 35%
9,150
12,500
3,011.50 + 37%
12,500

On the bright side, tax reform increased the standard deduction for singles to $12,000 (2018), meaning that a child can make up to $12,000 of earned income tax-free. The standard deduction is inflation adjusted for future years.

Uncoupling the child’s return from the parents’ return also solved another problem. If a child had taxable unearned income, they previously would have to wait for the parents’ return to be prepared to know what the parents’ top tax rate was before the child’s return could be prepared. It was not uncommon for young adults, in a rush for their tax refund, to jump the gun and file their own return while ignoring the kiddie tax rules, only to have to amend their returns. That is no longer the case.

If you have questions, please give this office a call.


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Offices in Flemington, NJ and Califon, NJ

Our Mission: At Prestige Accounting Services Group (previously Prestige Wealth Accounting Group), we are on a mission to redefine the tax experience for individuals and small businesses. With a focus on personalized service, strategic planning, and expert guidance, we aim to empower our clients to succeed financially with confidence and ease.

Expertise in Action: With a wealth of experience and a team of dedicated professionals, we specialize in individual and small business tax preparation. While we excel in all areas of taxation, our passion lies in serving the unique needs of small business owners in New Jersey. We understand that small business taxation requires specialized knowledge and attention to detail, which is why we go above and beyond to ensure our clients receive the guidance and support they deserve.

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Why Choose Us?: What sets us apart from other New Jersey tax firms is our commitment to excellence and innovation in the field of taxation. We don't just prepare tax returns; we provide strategic insights, proactive planning, and actionable advice to help our clients achieve their financial goals. With a team of two CPAs, an EA, and an ERO, we have the expertise and resources to deliver exceptional service and results.

Your Success is Our Priority: At Prestige Accounting Services Group (previously Prestige Wealth Accounting Group), we measure our success by the success of our clients. We are dedicated to building long-lasting relationships, providing unparalleled service, and helping our clients thrive in today's ever-changing tax landscape.

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