New Kiddie Tax Rules and Rates for 2018
Mowing the lawn, shoveling the driveway, teaching their parents how to use their tablets and phones – these are all ways kids and teens can earn some spending money. No matter how modest that compensation may be, every dollar of it constitutes “earned income.” But kids can also make plenty of “unearned income” in the form of gifts, stock, interest, dividends, and capital gains on investments and accounts in their name.
Whether earned or unearned, kids who discover what its like to make or earn a significant sum of money may also discover what it means to be a taxpayer, even if they are a dependent on their parents’ tax return.
What is the “Kiddie Tax”?
The “Kiddie Tax,” as it is commonly called, actually refers to the “Tax on a Child’s Investment and Other Unearned Income.” The Kiddie Tax was enacted in 1986 in an effort to thwart wealthy taxpayers from taking advantage of their kids’ lower tax rates. After documenting numerous examples of such creative misappropriation, lawmakers saw the opportunity to prevent people from shifting income-producing assets to their children and thereby avoid their tax obligations.
How the New Tax Law Changed the Kiddie Tax
For the first two decades of the Kiddie Tax’s existence, any unearned income above a certain threshold earned by a child under age 17 was taxed at the parents’ tax rate. Beginning with the 2018 tax year, the 2017 overhaul of the tax code changed who the tax applied to, altered the threshold on the amounts that would trigger the tax, and modified the basic formula, correlating the tax rate to the amounts earned rather than the parents’ rate.
In its newest incarnation, the Kiddie Tax applies to nearly all children 19 and under and many adults who are under 24, if they are full-time students and aren’t self-supporting.
Parents’ Tax Rate No Longer Used
Previously, a child’s net unearned income (anything over $2,100) was added to their parent’s taxable income to determine the incremental tax liability, which was then allocated to the child’s tax return and taxed at the parents’ marginal rate.
H3: Kiddie tax calculation for 2018
Now, starting with 2018 returns, the first $1,050 of investment income for a child will be tax-free, while the next $1,050 will trigger the need for the child to file a return and will be taxed at 10%. Above that, a child’s unearned income over $2,100 will be taxed at the rates that apply to trusts and estates. For 2018, those rates are:
- Up to $2,550: 10%
- $2,550 to $9,150: 24%
- $9,150 to $12,500: 35%
- Over $12,500: 37%
All of the above changes apply to a child’s unearned income only. If a child earns money from wages and salary, and has no unearned income, their earnings up to $12,000 will be tax-free and they will not need to file a return. If, however, a child has both unearned and earned income, he or she must file a return for tax year 2018 if:
- unearned income was over $1,050
- earned income was over $12,000, or
- earned and unearned income together total more than the larger of (1) $1,050, or (2) total earned income (up to $12,000) plus $350.
The decoupling of a child’s unearned income from the parents’ tax rate should make calculating the applicable tax easier. That is the good news. The bad news is that the result of that calculation could reveal a tax liability significantly larger than it was previously.
Whether your child earns income from investments or hard work, it is important to understand how the tax law changes may impact your investment or tax strategies. If you have questions about how the Kiddie Tax applies to your family and how you can best minimize your tax obligations, please contact us. We welcome the opportunity to assist you.