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Beware the Kiddie Tax

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Income shifting is defined as a person in a high tax bracket giving an income producing or appreciated asset to another person, typically a child, who is in a lower tax bracket to hold or sell.

This transfer is sometimes made to a child under the age of eighteen and is held in either an account under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA). The unearned income from the account then used be taxed at the child’s tax rate. Seems simple enough, right? Enter the Kiddie Tax. 

Since the IRS does not appreciate not receiving taxes on earned income, the Kiddie Tax first came into being in 1986 and has changed several times. Under the rules prior to 2018, unearned income to a minor more than $2,100 was taxed at their parent’s tax rate. The calculation could be complicated especially if more than one minor was involved.

Changes to the code under the Tax Cuts and Jobs Act simplified the calculation but seems to have made the tax due more onerous as the taxes due are now calculated using the rates for Trusts and Estates.

Kiddie Taxable Unearned Income

(Trust and Estate Rates)

Tax Rate
up to $2,550 10%
$2,551 to $9,150 24%
$9,151 to $12,500 35%
all over $12,501 37%

(Unearned income is typically defined as interest and ordinary dividends.)

Trust and Estate Tax rates also apply to Long Term Capital Gains (assets held longer than on year) and Qualified Dividends (ordinary dividends that meet specific IRS criteria that are taxed at long term capital gains rates.)

Kiddie Tax LTCG/Qualified Dividends

(Trust and Estate Rates)

Tax

Rate

$0 to $2,600   0%
$2,601 to $12,700 15%
$12,01 and Over 20%

 

An additional change is minors age are now age 19 (24 if the child is a full-time student.)

If you are considering shifting income to a minor, it is important to monitor the amount of income that may be earned by your minor child. Otherwise, you may wind up paying more in taxes than if you keep the assets and paying the taxes under your own rates.

Bill Mayer CFP®
BMayer@AddisHill.com

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