You may have
heard that there are issues with the new kiddie tax.
There are.
The kiddie
tax has been around for decades.
Standard tax
planning includes carving out highly-taxed parental or grandparental income and
dropping it down to a child/young adult. The income of choice is investment
income: interest, dividends, royalties and the like. The child starts his/her
own tax bracket climb, providing tax savings because the parents or
grandparents had presumably maxed out their own brackets.
Congress
thought this was an imminent threat to the Union.
Which
beggars the question of how many trust fund babies are out there anyway. I have
met a few over the decades – not enough to create a tax just for them, mind you
- but I am only a tax CPA. It is not like I would run into them at work or
anything.
The rules
used to be relatively straightforward but hard to work with in practice.
(1) The rules would apply to unearned income. They
did not apply if your child starred in a Hollywood movie. It would apply to the
stocks and bonds that you purchased for the child with the paycheck from that
movie.
(2) The rules applied to a dependent child under
19.
(3) The rules applied to dependents age 19 to 23
if they were in college.
(4) The child’s first $1,050 of taxable unearned
income was tax-free.
(5) The child’s next $1,050 of taxable unearned
income was taxed at the child’s tax rate.
(6) Unearned income above that threshold was taxed
at the parent’s tax rate.
It was a
pain for practitioners because it required one to have all the returns prepared
except for the tax because of the interdependency of the calculation.
For example,
let’s say that you combined the parents and child’s income, resulting in
$185,000 of combined taxable income. The child had $3,500 of taxable interest.
The joint marginal tax rate (let’s assume the parents were married) at $185,000
was 28%. The $3,500 interest income times 28% tax rate meant the child owed
$980.
Not as good
as the child having his/her own tax rates, but there was some rationale. As a
family unit, little had been accomplished by shifting the investment income to
the child or children.
Then
Congress decided that the kiddie tax would stop using this piggy-back
arithmetic and use trust tax rates instead.
Problem: have
you seen the trust tax rates?
Here they are for 2018:
Taxable Income The Tax Is
Not over $2,550 10%
$2,551 to $9,150 $
255 plus 24% of excess
$9,151 to $12,500 $1,839
plus 35% of excess
Over $12,500 $3,011.50 plus 37% of excess
Egad.
Ahh, but it
is just rich kids, right?
Not quite.
How much of
a college scholarship is taxable, as an example?
None of it,
you say.
Wrong,
padawan. To the extent not used for tuition, fees and books, that scholarship
is taxable.
So you have
a kid from a limited-means background who gets a full ride to a school. To the
extent the ride includes room and board, Congress thinks that they should pay
tax. At trust tax rates.
Where is that
kid supposed to come up with the money?
What about a
child receiving benefits because he/she lost a parent serving in the military?
These are the “Gold Star” kids, and the issue arises because the surviving
parent cannot receive both Department of Defense and Department of Veteran
Affairs benefits. It is common to assign one to the child or children.
Bam! Trust
tax rates.
Can Congress
fix this?
Sure. They caused
the problem.
What sets up
the kiddie tax is “unearned” income. Congress can pass a law that says that
college room and board is not unearned income or that Gold Star family benefits
are not unearned income.
However, Congress
would have started a list, and someone has to remember to update the list. Is
this a reasonable expectation from the same crew who forgot to link leasehold
improvements to the new depreciation rules? Talk to the fast food industry.
They will burn your ear off on that topic.
Congress
should have just left the kiddie tax alone.
