|The kiddie tax rules changed substantially in 2018. Income over the kiddie tax threshold is now taxed at the rate on trusts, independent of the parents' rates. Please ask for assistance in the forum.[note 1]|
The Kiddie tax rule can be found in the US tax code which "taxes certain unearned income of a child at the parent’s marginal rate, no matter whether the child can be claimed as a dependent on the parent’s return." The updates are in section A(1)(11001)(a)(4) of the 2018 tax law.
The kiddie tax in general
There are two rules that may affect the tax and reporting of the investment income of certain children:
- If the child's interest, dividends and other unearned income total more than $2,100 in 2018, $2,200 in 2019 (twice the basic standard deduction for a dependent minor of $1,050 or $1,100, indexed for inflation[note 2]), part of that income may be subject to tax at the rate for trusts (in 2018 and later) instead of the child's tax rate.
- If the child's interest and dividend income (including capital gain distributions) total less than $11,000 (10 times the basic standard deduction of $1,100), the child's parent may be able to elect to include that income on the parent's return rather than file a return for the child. This may result in paying more tax than having the child file a tax return, but given the high tax rates for trusts, it might also result in paying lower tax. (See Form 8814 and Publication 929).
The following characterizes the kiddie tax:
- Very complex
- Applies if the child is < 24 and a full time student (lower ages if not), and has > $2,100 in unearned income for 2018, $2,200 for 2019
- Anything over $2,100 or $2,200 in unearned income is taxed at the tax rate for trusts
- Kiddie tax is calculated on Form 8615 and paid on child's return
- The standard deduction for a child who can be claimed as a dependent is the greater of
- $1,050 for 2018, $1,100 for 2019 (indexed for inflation)
- earned income plus $350 for 2018 or 2019 (indexed for inflation) but not more than the regular standard deduction amount, generally $12,000 for 2018, $12,200 for 2019 (indexed for inflation)
- Note that by gifting appreciated securities to a child, one can save at most $698 per year per child in capital gains tax in 2018 and $713 in 2019 (if in the 15% Long Term Capital Gains (LTCG) bracket) and up to $1,110 per year per child (if in the 37% bracket with tax loss carryover, see note below)
Taxation of children with no earned income
If the children have no earned income then:
- The child (if a dependent) gets a Standard Deduction of $1,100
- This has the effect of:
- The first $1,100 of unearned income is untaxed
- The next $1,100 is taxed at the child's rate
- 0% for qualified dividend (QDI) and long term capital gain (LTCG)
- 10% for Interest and non-QDI
- Anything beyond that is taxed at the rate for trusts (in 2018)
Taxation of children with earned income
If the children have earned income then:
- The standard deduction is $1,050 for 2018, $1,100 for 2019 or (earned income + $350), whichever is larger, but not more than the normal standard deduction of $12,000 for 2018, $12,200 for 2019 (indexed for inflation) for a single person.
Example 1: A child has $200 of earned income. His standard deduction is $1,100. With $500 of ordinary unearned income (interest, short-term capital gains (STCG), and non-QDI) and $1,300 of tax advantaged unearned income (QDI and LTCG), his total income is $2,000, and his taxable income is $900. Under the "income stacking rules" of the Qualified Dividends and Capital Gain Tax worksheet, all of his taxable income is tax advantaged, and his tax is $0.
Example 2: A child has $1,200 of earned income. Her standard deduction is $1,550 ($1,200 + $350). With $500 of ordinary unearned income (interest, STCG, and non-QDI) and $1,300 of tax advantaged unearned income (QDI and LTCG) her total income is $3,000, and her taxable income is $1,450. Under the "income stacking rules" of the Qualified Dividends and Capital Gain Tax worksheet, the taxable income consists of $150 of ordinary income ($500 - $350) and $1,300 of tax advantaged income. Her tax will be $15 (10% of $150).
Example 3: Your child has no other income than $3,000 of LTCG from stock you gave her. Her standard deduction is $1,100 and her taxable income is $1,900. In 2019, since her unearned income is over $2,200, the last $800 is taxed at the trust rate. Since trusts pay tax at 0% on the first $2,650 of LTCG, there is no tax due. If she had $5,000 of LTCG, there would be $2,800 taxed at the trust rate, with the last $150 taxed at 15% for a $23 tax bill.
Example 4: Your child has no other income than $1,000 of LTCG from stock you gave him. His standard deduction is $1,100 and his taxable income is zero. You save $150 (15% of $1,000) in the 15% LTCG bracket.
- The changes are significant, as trusts/estate taxes have much lower capital gain tax thresholds than individuals. See posts starting from Bogleheads® forum post: for additional details.
- The basic standard deduction is indexed for inflation. The unearned income limit is twice that amount. Source: 26 USC 63:(c)(4) and 26 USC 1:(g)(4)(A)
Tax loss carryover
If a parent is in the 37% marginal income tax bracket and already has a $3,000 tax loss carryover, then a long-term capital gain of $3,000 will be offset by that $3,000 loss and no tax will be due. However, the $3,000 tax loss carryover could have been used to offset ordinary income if it exceeds the parents' capital gains; that would save 37% of $3,000, which is $1,110, and the child would pay no tax. Thus, gifting to a child may still make financial sense.
- 26 U.S. Code § 1 - Tax imposed | LII / Legal Information Institute, viewed January 24, 2015.
- Samuel Donaldson, Federal Income Taxation of Individuals: Cases, Problems and Materials 639 (Thomson West 2007) (2005).
- Tax Topics - Topic 553 Tax on a Child's Investment Income (Kiddie Tax), viewed January 24, 2015.