Kiddie Tax No Longer Based on Parents’ Tax Rate

 

Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the first $1,050 of a child’s investment income (unearned income) such as interest, dividends and capital gains was tax-free. The next $1,050 was taxed at just 10% and any unearned income above $2,100 was taxed at his or her parents’ higher tax rate. A child’s earned income (generally income from wages) was taxed at the single rate, and the child could use the regular standard deduction for single individuals ($6,350 in 2017) to reduce his or her taxable earned income.

With tax reform, for years 2018 through 2025, the first $2,100 of the child’s unearned income is being taxed as before, with the first $1,050 being tax-free and the next $1,050 being taxed at 10%. However, instead of the balance being taxed at the parents’ tax rate, the balance is taxed at the income tax rates for estates and trusts, which for 2018 hits 37% when the balance of the unearned income reaches $12,500. The income tax rates for trusts and estates are illustrated below.

2018 Federal Tax Rate Schedule – Estates & Trusts

   If the taxable income is:    The tax is:
      Over But not over Of the amount over    
$0 $2,550 10% $0
2,550 9,150 $255.00 + 24% 2,550
9,150 12,500 1,839.00 + 35% 9,150
12,500 3,011.50 + 37% 12,500

On the bright side, tax reform increased the standard deduction for singles to $12,000 (2018), meaning that a child can make up to $12,000 of earned income tax-free. The standard deduction is inflation adjusted for future years.

Uncoupling the child’s return from the parents’ return also solved another problem. If a child had taxable unearned income, they previously would have to wait for the parents’ return to be prepared to know what the parents’ top tax rate was before the child’s return could be prepared. It was not uncommon for young adults, in a rush for their tax refund, to jump the gun and file their own return while ignoring the kiddie tax rules, only to have to amend their returns. That is no longer the case.