Congress took a tax calculation that was already a
headache and made it worse.
I am looking at a tax change included in the year-end
budget resolution.
Let’s talk again about the kiddie tax.
Years ago a relatively routine tax technique was to
transfer income-producing assets to children and young adults. The technique
was used mainly by high-income types (of course, as it requires income), and
the idea was to redirect income that would be taxed at a parent’s or
grandparent’s (presumably maximum) tax rate and tax it instead at a child/young
adult’s lower tax rate.
As a parent, I immediately see issues with this
technique. What if one of my kids is responsible and another is not? What if I
am not willing to just transfer assets to my kids – or anyone for that matter? What
if I do not wish to maximally privilege my kids before they even reach maturity?
Nonetheless, the technique was there.
Congress of course saw the latent destruction of the republic.
Enter the kiddie tax in 1986.
In a classroom setting, the idea was to slice a kid’s
income into three layers:
(1) The first $1,050
(2) The second $1,050
(3) The rest of the kid’s income
Having sliced the income, one next calculated the tax
on the slices:
(1) The first $1,050 was tax-free.
(2) The second $1,050 was taxed at the kid’s own
tax rate.
(3) The rest was taxed at the parents’ tax rate.
Let’s use an example:
(1) In 2017 the kid has $20,100 of income.
(2) The parents are at a marginal 25% tax rate.
Here goes:
(1) Tax on the first slice is zero (-0-).
(2) Let’s say the tax on the second slice is $105
($1,050 times 10%).
(3) Tax on the third slice is $4,500 (($20,100 –
2,100) times 25%).
The kid’s total 2017 tax is $4,605.
Let’s take the
same numbers but change the tax year to 2018.
The tax is now $5,152.
Almost 12% more.
What happened?
Congress changed the tax rate for slice (3). It used
to be the parent’s tax rate, but starting in 2018 one is to use trust tax rates
instead.
If you have never seen trust rates before, here you
go:
Have over $12,500 of taxable income and pay the
maximum tax rate. I get the reasoning (presumably anyone using trusts is
already at a maximum tax rate), but I still consider these rates to be
extortion. Sometimes trusts are just that: one is providing security,
navigating government programs or just protecting someone from their darker
spirits. There is no mention of maximum tax rates in that sentence.
Let’s add gas to the fire.
The kiddie tax is paid on unearned income. The easiest
type to understand is dividends and interest.
You know what else Congress considered to be unearned
income?
Government benefits paid children whose parent was
killed in military service. These are the “Gold Star” families you may have
read about.
Guess what else?
Room and board provided college students on
scholarship.
Seriously? We are taking people unlikely to be racking
Thurston Howell III-level bucks and subjecting them to maximum tax
rates?
Fortunately, Congress – in one of its few accomplishments
for 2019 – repealed this change to the kiddie tax.
We are back to the previous law. While a pain, it was
less a pain than what we got for 2018.
One more thing.
Kids who got affected by the kiddie tax changes can go
back and amend their 2018 return.
I intend to review kiddie-tax returns here at Galactic
Command to determine whether amending is worthwhile.
It’s a bit late for those affected, but it is
something.
