Definition
The Kiddie Tax is a term referring to a special tax law implemented in 1986 involving investment and unearned income tax for individuals below 17 years of age.
What is unearned income?
Also known as “passive” income, unearned income are those that don’t involve active work or a business activity such as the following:
How does it work?
Individuals below the age of 17 with an investment and unearned income that is higher than an annually determined threshold are expected to receive a Kiddie Tax. Before 2018, any income more than the predetermined threshold is imposed with tax by the IRS at the rate of the child’s guardian. A huge change happened to the Kiddie Tax due to The Tax Cuts and Jobs Act of 2017. Today, once a child’s income goes more than the threshold, a taxation structure is used by the Kiddie Tax where the amount earned controls the tax rate instead of the child’s parents tax rate.
What is the purpose of the Kiddie Tax Law?
It was designed to stop parents from taking advantage of the tax loophole where their children are granted huge gifts of stock. The child will then be able to realize any gains from the investments and will be taxed at a much lower rate versus the rate the guardians face for their realized stocks gains.
What and to Whom Does the Kiddie Tax Applies to?
The Kiddie Tax is applicable to all children 19 and below as of 2018 as well as children between the ages of 19 and 23 who are dependent full-time students. Unearned income received by the child imposed with Kiddie Tax includes gifts, inheritances, cash, stocks, bonds, mutual funds, and real estate. There is a tax imposed on any salary or wages the child earns.
How and When did the Kiddie Tax Law Began?
In the beginning, only children under the age of 14 years are covered by the Kiddie Tax Law. It is a common knowledge that children below the age of 14 cannot work legally which means any income the child earned usually came from dividends or interests from bonds. Unfortunately, tax authorities, later on, found out that some guardians would abuse the situation by giving stock gifts to their older children ages 16 to 18 years old. There was no tax imposed on the first $1,050 because it is the tax threshold set in 2017. The IRS, later on, taxed the second $1,050 at the child’s tax rate which extremely low and sometimes results to zero percent. Any income higher than $2,100 was subject to tax at the guardian’s tax rate and could be as high as 39.6 percent.
The Tax Cuts and Jobs Act made the Kiddie Tax simpler beginning in 2018. However, it’s current iteration will remain the same until 2025. The Kiddie Tax in the new form remains the same for the first $2,100 of unearned income but the IRS will impose a tax to the amounts higher than $2,100 at the rates related to various income brackets which is the opposite of their parent’s tax rate. The rates range with anything up to $2,500 taxed at 10 percent, $2,551 to $9,150 at 24 percent, $9,151 to $12,500 at 35 percent and anything over $12,501 at 37 percent.
How to report and pay Kiddie Tax?
The Kiddie Tax must be reported on your child’s return or yours depending on whether or not you met certain conditions. However, including your child’s income on your tax return will not only increase the tax you owe but it may also phase out certain deductions and credit you could’ve claimed by doing otherwise. Because of this, a lot of people choose to file their return separately with their child to report this tax.
It’s always best to ask for a tax professional advice if you’re not sure what to do with Kiddie Tax and to be able to file the right tax return.
