Congress recently reduced the tax burden for many families with investments in a child’s name—after having increased the tax burden just two years earlier. The lawmakers essentially did an about-face on the so-called kiddie tax. The action, which is a little-noticed part of the new law called the Secure Act, changes the tax treatment for children with “unearned income” from investments in their names, starting with the 2020 tax year (and optional retroactively for the 2018 and 2019 tax years). It could save some families thousands of dollars and encourage some parents or grandparents to put investments in children’s names in order to eventually save on estate taxes.
What you need to know to make the best use of the new kiddie tax rules: Since the tax year 1987, unearned income that children receive (but not earned income from, say, a summer job) has been subject to the kiddie tax. The rules were aimed at discouraging parents from shifting investments to children to save on taxes. Through 2017, that meant children with unearned income above a certain level paid capital-gains tax (for long-term stock gains and qualified dividends) or income tax (for short-term capital gains and interest) based on the federal income tax bracket of their parents.
However, starting with the 2018 tax year and continuing in 2019, it no longer mattered how much taxable income the parents had. Children were required to pay tax based on the same rates as trusts and estates—meaning that for income above $12,750 in 2019, they would pay a tax rate of 37% on ordinary investment income. That meant much higher taxes than before for most families and lower taxes than before for some families with extremely high-income parents.
What happens now under the new rules: For 2020, a child with unearned income exceeding $2,200 once again pays the same tax rate on amounts above that level as his/her parents would on their own investments. Should you still gift investments if you can’t save on taxes? It’s attractive to make gifts now in order to reduce the size of a large estate that might eventually be subject to high estate taxes. Also, check whether it’s worth refiling taxes on children’s investments for 2018/2019 to get the revised tax rates and a possible kiddie tax refund.