Historically, parents have moved investments under their children’s names to reduce the taxes on investment income, up to a limit. After reaching that limit, the investment income was taxed at the parents’ tax rate. With the 2017 Tax Cuts and Jobs Act (TCJA), the kiddie tax rules have changed. Possible re-thinking and planning ahead may be needed to reduce taxes using investments in children’s names.
- “Kiddies” refers to children under age 19 and full-time students, under age 24, who don’t support themselves financially.
- Investment income refers to all income from investments such as dividends, interest, and capital gains.
Up until 2017, the first $2,100 of investment income for these “kiddies” was tax-free. Income over this amount was taxed at the parents’ tax rate. In 2018 through 2025, the first $2,100 remains tax-free. Additional income, though, is taxed at “Estate and Trust” tax rates. The parents’ tax bracket no longer makes any difference.
Under the old rules, the income from families with several children could make a difference in the tax consequences for all of the children. Now each child is considered independently. In a way, this is simpler – at least for the calculations – but the consequences are potentially more onerous.
The new tax rates on investment earnings of dependent children in excess of $2,100 will be taxed at the following rates for interest and short-term capital gains:
- Up to $2,550 taxed at 10 percent
- From $2,550 to $9,150 taxed at 24 percent
- From $9,150 to $12,500 taxed at 35 percent
- Over $12,500 taxed at 37 percent
A married filing jointly taxpayer does not reach the 37% tax bracket until they have more than $600,000 in taxable income.
The tax rates for children’s dividends and long-term capital gains are as follows:
- Up to $2,600 at 0 percent,
- From $2,601 to $12,700 taxed at 15 percent,
- Over $12,700 taxed at 20%.
Again, a married filing jointly taxpayer does not reach the 20% tax bracket until they have taxable income of more than $77,200 in taxable income. The children reach the highest bracket a lot sooner than the parents.
The need for careful planning for your children’s taxes increased with the new tax law. The amount of income generated by accounts in your children’s names may reach the 35 percent or 37 percent rate if you are not paying attention. If the accounts have significant unrealized capital gains, which you’d like to realize by selling in order to pay for college, then some strategic planning may be needed to reduce the capital gains taxes due.
Parents and grandparents who traditionally gift to their children or grandchildren need to consider the tax impact prior to gifting. Techniques to consider may be gifting between the parent and child to allocate the income appropriately so to have the least tax consequences on the income. If you have appreciated stock, you could possibly plan and schedule the dispositions over several years and reduce the corresponding capital gains rate from as high as 23.8 percent down to 0. Another possibility with substantial investment income that could legally put the college-age child into an independent category is for the child to file their tax return as an independent adult.
The key is to begin the planning process ahead of time. While the calculation for the new kiddie tax is more straightforward, the overall variables are more complicated, and the tax consequences potentially more severe. You don’t want to wait to begin this planning process. It may be worth considering the strategy when the child is as young as middle school. It is important to consult with your tax advisor to understand the tax impact on the whole family. A thoughtful plan will help to minimize the tax liability.
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