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Ouch! Watch Out for the “Kiddie Tax”

  • August 2019 | by Abbott Pratt & Associates

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    I have always taken a proactive approach when it came to planning for my financial future. After recently passing the one-year mark of parenthood, and seeing my financial plan evolve, I have begun to dive deep into the impacts of what my son’s tax situation might look like in the years to come as well. I have asked myself, do I open a brokerage account in his name, what is the right amount to put into a 529 plan each year, should he just have a basic savings, or is a life insurance policy with cash surrender build up the best play? With all these questions bouncing back and forth, the “unearned income” component of a brokerage account, and the resulting “kiddie tax” really made me pause for a moment and reevaluate things.

    So, what is this “Kiddie Tax” ?

    The kiddie tax used to apply only to children under age 14 — which provided families with plenty of opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).

    What about the kiddie tax rate? Before recent changes in tax laws, for children subject to the kiddie tax, any unearned income beyond a certain amount was taxed at their parents’ marginal rate (assuming it was higher), rather than their own rate, which was likely lower.

    Now that’s a tax rate

    The new tax law doesn’t further expand who’s subject to the kiddie tax. But it has effectively increased the kiddie tax rate in many cases.

    For 2018–2025, a child’s unearned income beyond the threshold ($2,200 for 2019) will be taxed according to the tax brackets used for trusts and estates. For ordinary income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2019 taxable income exceeds $12,750. In contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2019 taxable income tops $612,350.

    Similarly, the 15% long-term capital gains rate begins to take effect at $78,750 for joint filers in 2019 but at only $2,650 for trusts and estates. And the 20% rate kicks in at $488,850 and $12,950, respectively.

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