Major Changes Come to Kiddie Tax

The SECURE Act's fix to the TCJA glitch — that's how Forbes describes what's been going on with the football that is called the Kiddie Tax. When the Tax Cuts and Jobs Act changed the way the Kiddie Tax was figured, it caused a lot of concern for families with children with unearned income. The fix is retroactive for 2019 and 2018 returns.

The Kiddie Tax was intended to prevent parents from using kids to get unfair tax advantages — children are taxed at far lower rates than working parents are. The Kiddie Tax, which aimed to stop this by forcing children to pay their parents' tax rate on income above certain levels, went through major changes in late 2017 as part of the broader tax reform package.

Tax reform changed the rules and for two years, rather than using parents' tax rates, the rules forced taxpayers to use the rates for trusts and estates. Those rates run from 10% to 37%, just like tax brackets for individuals and couples but greatly compressed — the top 37% bracket kicked in at just $12,750 for the 2019 tax year. It meant that even low-income families were charged high tax rates.

More recently, though, lawmakers decided to shift some of the provisions back, making parents once again get up to speed on which laws apply.

Here's the updated SECURE 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.
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If you've been hit by the Kiddie Tax in recent years, speak with a financial professional about a possible retroactive adjustment.