The Kiddie Tax Overhaul in the TCJA Actually An Improvement

If there’s part of the tax code makes me feel a little icky, it’s the awkwardly named Kiddie Tax. No, that’s not the official Washington approved name, but it’s stuck somehow, likely due to some heavyset blonde accountant–with a wisp of a moustache creeping on his upper lip–preparing cut rate tax returns from the back of his unmarked van.

The kiddie tax (bleh), as a quick review, is an attempt to stop parents in high tax brackets from dumping money onto their low tax bracket children in order to lower their overall tax bill. Like so many other tax laws, it was made to thwart schemes by 1%ers with high cost accountants and lawyers, but, unfortunately, has inadvertently caught others in the kiddie tax net (ug, I think I need to take a shower).

Tax Reform, or TCJA (pronounced Tick Jaw, which is probably the Bizarro World version of The Tick) decided to change up the kiddie tax by actually making it less difficult to calculate.

I have to admit, I’m a bit surprised by the change. After all the hoopla from the President’s Office about tax returns and postcards, most of the actual reform made things, at best, only slightly more confusing.

The kiddie tax change is honestly a really good simplification.

And as you can see from this picture here, Mommy’s life was much more glamorous before you came along and made everything more complicated

Let’s go through this together.

This law still applies to the same group of people as pre-reform, which is kiddies *shudders* are children who are under 19 years old or full-time students under 24, with at least one living parent, and are not filing a joint tax return (i.e. it doesn’t affect child brides and grooms).

If that child as earned income, like from that part time job as a sandwich artist, his or her income is taxed just like a single individual.

If, however, the child has unearned income (which is generally defined as interest or dividends from Grandma’s provided T-bonds or GE stock), that income is taxed as if it were an Estate or Trust. Let’s pull up those brackets:

Estate and Trust Income (or Unearned Income for Qualified Children) Rate
Up to $2,550 10%
2,551 to 9,150 24%
9,151 to 12,500 35%
$12,500 and up 37%

Let’s imagine Little Tommy has $5,000 in Microsoft dividends during the year. Since that is unearned income, Tommy gets to pay 10% taxes on the first $2,550, then 24% taxes on the remaining amount, or total taxes of $843.

It’s important to note that the rules are written such that the earned income is basically in a separate bucket. So if Tommy also gets $5,000 from working as a Life Guard, he’s not suddenly in the 35% tax bracket for his unearned income.

Capital Gains would also fall under the Estate and Trust income tax rates. Those are, at least as of 2018, up to $2,600 taxed at 0%, up to $12,700 taxed at 15%, and the rest at 20%. However, these ARE in the same bucket as the unearned income. So if you have $5,000 of dividends and $3,000 in Capital Gains, all those gains are pushed up by the dividends into the 15% rate.

How Does This Help The Kiddie Tax?

If you’ve never dealt with the kiddie tax *blerg* before, then you’re probably thinking that none of this is particularly great. But it’s WAY better than before. Previously, if you wanted to figure out a child’s tax liability, you first had to figure out the parent’s. Then the kid would use the same marginal rate that the parent would use.

As you can probably guess, it made it extremely difficult to give anything approaching an accurate estimate on taxes.

This disentangles the child’s taxes from the parents. It may or may not end up having a better tax effect, but it makes the calculation much less confusing