TAX110 - FAQ: Explanation of the Kiddie Tax

The Kiddie Tax

Presented by Tim Weller

The IRS’s kiddie tax rules limit parents’ ability to transfer investment assets to a minor child in order to take advantage of the child’s lower marginal tax bracket.

The kiddie tax applies to the following groups:

Children younger than 18
Children age 18 whose earned income does not exceed one-half of their support
Children at least age 19 but younger than 24 who are full-time students and whose earned income does not exceed one-half of their support (A student is considered full-time if he or she is a full-time student during any part of at least five months during the year.)

Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), if a child’s net unearned income was above an indexed threshold, it would be taxed at the parents’ tax rate (if the parents’ rate was higher). Under the TCJA, if a child’s unearned income is above the specified threshold, it will be taxed at rates comparable to trust tax rates included in the chart below. For 2020, the threshold amount is $2,200.

If taxable income is:	The tax is:
$2,600 and under	10% of the taxable income
Over $2,600 but not over $9,450	$260 plus 24% of the excess over $2,600
Over $9,300 but not over $12,950	$1,904 plus 35% of the excess over $9,450
Over $12,950	$3,129 plus 37% of the excess over $12,950

Tax Planning Strategies

Consider investments that potentially generate tax-exempt income, such as municipal bonds*; investments that defer tax, such as U.S. savings bonds; or growth-oriented stocks and growth securities.
If taxable investment income is below the indexed threshold, consider electing to report U.S. savings bond interest each year.
If the child has earned income, consider investing the assets that are generating taxable investment income in a Roth IRA. Roth IRA qualified distributions generally aren’t subject to income tax.

If you decide on the third option, bear in mind that your contributions are not tax deductible because you can invest only after-tax dollars in a Roth IRA. If you meet certain conditions, your withdrawals will be free from federal income tax, including both contributions and investment earnings. To be eligible for these qualifying distributions, you must meet a five-year holding period requirement and one of the following must apply:

You have reached age 59½ by the time of the withdrawal.
The withdrawal is made because of disability.
The withdrawal (of up to $10,000) is made to pay first-time homebuyer expenses.
The withdrawal is made by your beneficiary or estate after your death.

*Municipal bonds are federally tax free but may be subject to state and local taxes, and interest income may be subject to federal alternative minimum tax (AMT).

Please note: The revised kiddie tax rules will expire after 2025 and revert back to the law in effect for 2017.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Tim Weller is a financial professional with Weller Group LLC at 6206 Slocum Road, Ontario, NY 14519. He offers securities as a Registered Representative of Commonwealth Financial Network®, Member FINRA/SIPC. He can be reached at 315-524-8000 or at tim@wellergroupllc.com.