Kiddie tax is imposed on individuals under 18 years old (or younger than 24 and a full-time student) whose investment and unearned income is higher than an annually determined threshold.
Unearned income is referred to funds such as interest, dividends, and capital gains, but not including wages. It was designed to prevent parents from passing their unearned income to their children and avoid paying higher tax rates. The 1986 tax reform act stated that certain types of unearned income, such as investment income, would be taxed as if the money was the income of the parent. Under the new law, as per the Tax Cuts and Jobs Act of 2017, a child’s investment income isn’t taxed at the parent’s marginal tax rate. Instead, it’s taxed at the rates applicable to trusts and estates.
Who must pay the Kiddie Tax?
Your child may be compelled to file a tax return to report and pay tax on income earned, however, may not be subjected to the Kiddie Tax. The Kiddie Tax normally kicks in when all the following criteria are met:
- Is required to file a tax return
- Has more than $2,100 of unearned income
- 18 or younger and didn’t earn income that was more than half their support at the end of the tax year
- Had at least one living parent at the end of the tax year
- Didn’t file a joint return for the year
How much is the Kiddie Tax?
Add up the child’s net earned income and net unearned income. Then subtract the child’s standard deduction to arrive at taxable income. The portion of taxable income that consists of net unearned income and that exceeds the unearned income threshold is subject to the Kiddie Tax. This rate can be as high as 37% for ordinary income and short-term gains and 20% for long-term gains and dividends.
How can you avoid paying the Kiddie Tax?
You can prevent paying the Kiddie Tax by keeping the child’s annual investment income at $2,100 or less. This can be attained by investing in things that increase in value. Another option is saving inside a 529 plan.
It’s not unusual for parents and grandparents to make financial gifts to children and young adults. Before you transfer income-producing assets, remember to consider the Kiddie Tax. Contact SSC Legal for advice to make sure the Kiddie Tax doesn’t come as an unwelcome surprise.
Frank R. Campisano is an experienced Estate Planning attorney with a long history of service and loyalty to his New Jersey clients. In addition, he can assist you with storing or updating your Last Will and Testament, college savings strategies, developing trusts, healthcare proxies, Power of Attorney documentation, and much more.