What is the Kiddie Tax?
In 1986, the Kiddie Tax was added to the tax code in order to prevent high wealth parents from shifting income-producing investment assets to their children who were in lower tax brackets.
How Did The Kiddie Tax Work in Prior Years?
In prior years, all unearned income from a child in excess of a predetermined amount ($2,100 for 2017) would be taxed. The unearned income would be added to the parent’s taxable income to determine the tax rate. This tax rate was then used on the child’s return to calculate the tax owed. This applied to all children under age 19 (or 24 if a full-time student and the parents provide more than half support).
What is Unearned Income?
Generally, unearned income is income from all sources not considered earned income. Earned income comes from employment or self-employed business activities. The most common form of unearned income is from dividends or interest from investments. For example, your child may have unearned income from dividends on stocks that you purchased in the child’s name.
How Does The New Kiddie Tax Work?
Beginning with the tax year 2018, the Kiddie Tax has been modified in two main ways. First, the child’s unearned income is no longer added to their parent’s income to determine the tax rate. Second, the tax rate will be determined by using the same tax brackets that a trust would use.
These changes will benefit most children who have modest unearned income. For those in multi-sibling households, the benefits are even greater. For example, in prior years all of the siblings’ unearned income would be aggregated to the parents return to determine the tax rate. All of the siblings would be subject to this tax rate irrespective of their actual amount of unearned income. Now, each child will be subject to the tax rate applicable only to his or her unearned income.
While most will benefit from these changes, for some with high amounts of unearned income their tax bill may end up being higher. Given this, it is important to discuss your tax situation and strategy with a qualified tax professional. Give our Milwaukee accounting firm a call today to learn more at 414-325-2040 or request a free consultation online.