Parents, Take Heed: The Kiddie Tax Has Changed (Again)
Thanks to the SECURE Act, parents of children or young adults may want to revisit how they deal with the kiddie tax this year. As you might know, the IRS’s kiddie tax was created to limit parents’ ability to transfer investment assets to a minor child in order to take advantage of the child’s lower marginal tax bracket.
The kiddie tax applies to:
- Children younger than 18
- 18-year-olds whose earned income does not exceed one-half of their support
- Full-time students age 19 through 25 whose earned income does not exceed one-half of their support
The SECURE Act rolls back certain changes passed with the Tax Cuts and Jobs Act of 2017 (TCJA). Under the TCJA, a child’s net unearned income above an annual threshold was taxed at rates comparable to the estate and trust tax rates, which could be unfavorable. Now, the kiddie tax reverts to pre-TCJA rules: The child’s net unearned income above the specified threshold ($2,200 in 2020) will be taxed at the parents’ tax rate. This change also applies retroactively to 2018 and 2019 tax returns.
What Could Help with Taxes?
You may wish to consider the following tax-planning strategies:
- Invest in municipal bonds,* which could generate tax-exempt income; vehicles that defer tax, such as U.S. savings bonds; and growth-oriented stocks and securities.
- If your taxable investment income is below the specified threshold for the kiddie tax, elect to report your U.S. savings bond interest each year.
- If your child has earned income, he or she could invest the assets that are generating taxable investment income in a custodial Roth IRA. Roth IRA qualified distributions generally aren’t subject to income tax. If certain conditions are met, including the five-year waiting period, withdrawals by the child, or on behalf of the child, will be free from federal income tax—for both contributions and investment earnings. Under the SECURE Act, penalty-free distributions could be made for adoption, childbirth, and qualified higher education expenses.
*Municipal bonds are federally tax free but may be subject to state and local taxes, and interest income may be subject to federal alternative minimum tax.
This material has been provided for general informational purposes only. It should not be construed as investment or tax advice, a solicitation, or a recommendation to buy or sell any security or investment product. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer. Investments are subject to risk, including the loss of principal.