As a taxpayer, if you have a child or young adult living in your home for more than half a year who does not provide for more than half of their own support, does not file a tax return jointly, and one or both parents are alive, taxpayers are accustomed to having a child tax credit available. However, it is important to be aware that as the same Kidde Tax rules apply as before, the Kiddie Tax rate structure has changed. The new tax structure change can make a significant difference in the amount of tax that may be owed and one should prepare ahead to understand how to help reduce the Kiddie Tax impact. It is no laughing matter as the new rates can be unfavorable, costing more.
The Tax Cuts and Job Act simplified the tax on the unearned income of children by applying ordinary and capital gains rates applicable to trusts and estates. This change is in effect from 2018 through 2025. Unearned income is income from investments rather than work; it is income one does not work to earn. For example, types of unearned income may include capital gains, dividends, interest, rent, pensions, alimony, or unemployment compensation. Children with significant unearned income will have more of an expense because they get hit by the compressed rates of the Kiddie Tax changes.
Children under the age of 18 and children up to the age of 24 can be affected. The aforementioned Kiddie Tax criteria come along with age-related rules as noted below:
- The child is 17 or younger at year end.
- The child is 18 at year end and doesn’t have earned income that exceeds half of his or her support. (Support doesn’t include amounts received as scholarships.)
- The child is age 19 to 23 at year end and 1) is a student, and 2) doesn’t have earned income that exceeds half of his or her support. A child is considered to be a student if he or she attends school full-time for at least five months during the year. (Again, support doesn’t include amounts received as scholarships.)
There is a simple way to calculate the Kiddie Tax: First, add the child’s net earned income to the child’s net unearned income. Second, deduct the standard deduction from that total for the amount of taxable income. The standard deduction amount for an individual who may be claimed as a dependent by another taxpayer cannot exceed the greater of: 1) $1,050 or 2) the sum of $350 plus the individual’s earned income. Then, the percent of earned income is taxed at the rate of a single taxpayer while the percent of the unearned income that exceeds the $2,100 threshold is subject to the Kiddie Tax. If it is less than the threshold, it does not apply. If the sum of unearned income is over $2,100.00, they will be taxed at the federal income tax trust and estate rate. Those rates can be as high as 37%.
This is no time for kidding around; it is time to plan thoughtfully for tax season.