The Senate released their tax proposal last week and one of the more buried details is in regards to the Kiddie Tax. Currently, many farmers gift grain to their kids or grandkids. For a Schedule F farmer, this can create very nice tax savings. It eliminates the self-employment tax on the grain gifted and under the kiddie tax rules, the tax rate of the child is usually equal to the parent's tax rate. Therefore, if the farmer is under the wage base amount ($128,700 in 2018), they will save about 15% due to making the gift to their child.
The Senate is proposing changing how the Kiddie Tax will work. Under current rules, the child usually simply pays income taxes based on the parent's tax rates (there is a small amount taxed at lower rates) on unearned income. Earned income such as wages is always at the child's tax rate. However, the Senate is proposing changing the child's tax rates on unearned income to be equal to the tax rates for estates and trusts. This means that once the child hits $12,500 of unearned income, they will be facing a maximum tax rate of 38.5% on all income above this amount. This will likely make it much more costly for farm families to gift grain to their children or grandchildren and receive any tax savings. Let's look at an example:
Farm couple Ben and Mary file as a Schedule F farmer. They are under the wage base. They gift their oldest son David $15,000 of grain. Ben and Mary are in the 15% tax bracket, therefore, the families only tax savings in the 15.3% of self-employment (SE) tax saved or about $2,300. The income tax that Ben and Mary saved by not reporting the $15,000 of grain sales on their return will be offset by the tax paid on David's return (we will assume David has enough other unearned income to subject the grain income to exactly the parents rate). The net savings to the family is about $2,300.
Under the Senate Proposal, Ben and Mary will still save about $2,300 on their SE tax and about $1,800 on their income tax (they are now in a 12% tax bracket) for total savings of about $4,100. However, David, when he files his return will owe at least $4,000 of income tax and it could be as high $5,775 ($15,000 X 38.5%). Therefore, the maximum tax savings for the family as a whole drops from $2,300 to savings of $100 to owing about $1,700. This will result in additional taxes owed of between $2,200 to $3,900.
Now let's assume that Ben and Mary are over the Wage Base amount. In this situation, the only tax savings under current law is the SE tax savings at 2.9% or about $435. Under the Senate proposal, the family will now see a tax increase of around $3,500 to perhaps as high as $5,300 if David has enough other unearned income to be in the maximum tax bracket.
As you can see, making commodity gifts to your children under the Senate proposal will net you much less tax savings and in many cases, the net result will be a tax increase.
We will keep you posted.