Taxpayers often use a common strategy called “shifting” to move income earning assets from their higher tax bracket to their children, who are typically in a lower tax bracket. While some tax savings are available, moving these assets could trigger what is called the “kiddie tax.”
The kiddie tax will impose limitations on the tax savings if any of the following are true:
- The child is under the age of 18 by the last day of the tax year
- The child’s earned income (through wages etc.) is less than half their annual support and the child is 18 or 19-23 and a full-time student.
And unearned or investment income is greater than $2,100.
Children who are subject to the kiddie tax are allowed to itemize their deductions, however most will use the standard deduction which is either $1,050 or the child’s earned wages plus $350 up to the basic standard deduction of $12,000.
Calculating the income subject to the kiddie tax became more complex due to a new concept of “earned taxable income” or ETI. ETI is calculated by taking taxable income less net unearned Income (unearned income less the standard deduction and the greater of $1,050 or the child’s itemized deductions related to unearned income.)
Earned taxable income must be computed before applying the correct tax brackets, which in 2018 match those used for estates and trusts.
Rate for capital gains and qualified dividends: Add the individual’s ETI to the rates below to determine tax bracket. For example, if your ETI is $2,000 then your taxable income can be $4,599 and still qualify for the 0% bracket.
$0-$2,599 0%
$2,600 – $12,699 15%
$12,700 – over 20%
Rate for ordinary income (includes wages and interest income), Add the individual’s ETI to the rates below to determine tax bracket. For example, if your ETI is $2,000 then your taxable income can be $4,550 and still qualify for the 10% bracket.
$0 – $2,550 10%
$2,551 – $9,150 24%
$9,151 – $12,500 35%
Over $12,500 37%
Although some of the new provision add complexity, the tax is no longer computed based on the parent’s income, therefore preparers won’t need to wait on the parents completed return to finish the child’s return.
For more information on how the kiddie tax may affect your family, contact your tax advisor.
