The Further Consolidated Appropriations Act adjusted the Kiddie Tax once again. Below, we’ll explain what’s changed and how to make your calculations.

History of the Kiddie Tax

The Kiddie Tax was established in 1986 to prevent parents from gifting their children large amounts of income-producing assets or investment property to take advantage of lower tax rates.

The Kiddie Tax aimed to stop this by forcing children to pay their parents’ tax rate on income above certain levels. Over the years, the Kiddie Tax has been subject to broad reforms that have had a few unintended (and highly publicized) consequences.

Take the Tax Cuts and Jobs Act of 2017 (TCJA), for example. It intended to simplify taxation by having taxpayers use the tax rate for trusts and estates for all their children’s unearned income.

The trouble was that this new rate impacted many with vastly different financial situations than those who typically received gifts of stocks and bonds. The 37% tax bracket kicked in at just $12,750 for the 2019 tax year, which meant that even low-income families were charged high tax rates.

Calculating the Kiddie Tax Today

Due to significant public uproar, lawmakers decided to shift some of the provisions back with the Further Consolidated Appropriations Act. That means that parents once again have to get up to speed on which laws apply.

Here’s the updated SECURE Act formula:

Child’s Net Earned Income + Child’s Net Unearned Income – Child’s Standard Deduction = Child’s Taxable Income.

So, if a dependent child has no earned income, but has unearned income (dividends and interest, for example) of $5,000 and the parents have $170,000 of taxable income, the calculation becomes: $0 + $5,000 – $1,100 = $3,900 taxable income.

This is $5,000 unearned income minus $2,200 Kiddie imputed exemption = $2,800 net unearned income. That $2,800 would be taxed. Under TCJA rules, the first $2,600 would be taxed at 10% and the $200 would be taxed at 24%.

If a dependent child owned rental real estate or received a significant income allocation from a closely-held business, the tax hit could be punishing.

Forbes provided an example: A dependent child with $42,000 of unearned income and no earned income and parents with $170,000 of taxable income. This leads to $40,900 of taxable income. In other words, $42,000 – $1,100 of standard deduction. Under TCJA rules, they’d have $13,063.50 of tax. Now with the repeal, the taxes would be $9,641. The qualified dividends still are subject to capital gains treatment, however.

If you’ve been hit by the Kiddie Tax in recent years, speak with a professional at Shea Labagh Dobberstein about a possible retroactive adjustment.

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