Tax Reform changed how the "Kiddie Tax" was calculated for certain children with unearned income. The Kiddie Tax applies to children under age 19 or is a full-time student under age 24. Under the old rules, the child's tax was essentially an extension of the parent's tax. For example, if the child had interest income of $15,000 and was subject to the Kiddie Tax, the tax would be calculated as follows:
- The first $1,100 was tax free,
- The next $1,100 was taxed at the child's tax rate (usually 10%) or $110,
- And the final $12,800 was taxed at the parent's tax rate (let's assume 15%) or $1,920 for final tax owed of $2,030.
Tax reform changed the method. The first two steps remain the same; however, the final step was eliminated and replaced with applying the trusts and estates tax rates. The top tax bracket of 37% would then apply once "bucket 3" income exceeded about $12,750.
In our example, instead of the child owing $2,030 of income tax, the child will now owe $3,204, a $1,174 tax increase (or 58% greater).
Congress was concerned that these changes unfairly impacted certain children receiving governmental payments because they are survivors of deceased military personnel (Gold Star children), first responders, and emergency medical doctors. All of these payments are considered unearned income and subject to Kiddie Tax in most situations.
In response, Congress elected to eliminate the new rules and go back to the old Kiddie Tax rules. This change is for all taxpayers, not just children receiving governmental payments.
This will be effective for tax years beginning in 2020, however, taxpayers have the option to apply the old Kiddie Tax rules to either 2018 or 2019. When filing children's tax returns this year, you will need to compare what the tax would be under either method and then choose the one that results in the least amount of tax owed. You may even need to check your 2018 calculation to see if an amended tax return should be filed to get a refund.
Most tax professionals likely would have preferred another solution. To calculate the Kiddie Tax under the old method was one of most complicated tax calculations and in many cases it was done incorrectly. Also, this now allows the minor child to see Mom and Dad's income.
Finally, for most farmers who have children that work on the farm, make sure to pay your child appropriate wages. A child can make up to $12,200 tax free and if their earnings from farm labor exceeds 50% of their support AND they are over age 18 at the end of the year, the Kiddie Tax will not apply to their unearned income. In that case, they will simply owe taxes on combined income at their normal tax brackets after deducting the $12,200 standard deduction (2019 numbers).