Change In The Kiddie Tax

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.

NCAA: From Cream Cheese To Endorsements

You may have read that the NCAA voted to allow students to benefit financially from the use of their name, image or likeness.

In truth, their hand was forced when California Governor Newsom signed the Fair Pay to Play Act on Lebron’s television show “The Shop.” Other states, including Florida, were also lining up on the issue.

Newsom was striking at an organization that realized over a $1 billion in revenues last year from “student-athletes,” all the while banning players from receiving any compensation other than scholarships.

Mind you, this is the same organization that used to ban schools from serving bagels with cream cheese. The NCAA argued (with a straight face somehow) that a bagel was a snack but a bagel with cream cheese was a meal. Meals were a no-go.

The tax hook for this post came from North Carolina (U.S.) Senator Richard Burr, who indicated he would introduce a bill to tax scholarships if the student-athlete also earns money from endorsements.

Methinks that Senator Burr is not a fan of the new rule.

Alternatively, he may subscribe to the new-economics theory of taxing something until it stops doing whatever triggered its taxation in the first place.

Did you know that some scholarships are already taxable?

Yep, the plain-old variety.

Scholarships used to be tax-free until 1980. The Code was then changed to look at whether services were being performed as a requirement for receiving the scholarship. Teaching assistantships would now be taxable, for example.

There was further change in 1986, when the Code began taxing scholarships used for living expenses.  If one received a scholarship, it was now important to determine whether it was for tuition or for room-and-board. Tuition was tax-free but room-and-board was not.

COMMENT: This change seems erratic to me, considering that The College Board has reported that living expenses make-up over half the cost of undergraduate education.

Scholarships for non-degree students next became taxable.

I would have to think about what national existential peril we barely avoided with that change to the tax law.

Senator Burr would add another exception-to-the-exception if you could buy a jersey with someone’s name on it. Alabama’s Tua Tagovailoa comes to mind. Your being able to buy a jersey with his name and number would make his scholarship taxable. It probably means little in Tua’s case, as he is projected to be a first round NFL draft selection. Take someone in a less prominent sport and the result might not feel as comfortable.

Then again, someone less prominent would probably not get into a payment-for-name, image-or-likeness situation.