In 1986, there was a law Passed that parents save money from taxes by transferring investments to their children’s names. Earlier, children’s investments were taxed at a lower child’s rate, and some wealthy parents would pursue investments to reduce their tax liability, especially for their children. The “kiddie tax” law changed the rules. In the first version of this law, which came into effect in 1987, the majority of investment income for children under 14 was taxed at the parental rate, limiting the benefit of transfer. Since then, the rules have changed many times.
KeyBank executive vice president Chris Manderfield says, “The Kiddie Tax, established in 1986 to avoid transferring large gifts of stock and other investments to parents to their children, is a tax avoidance.”
The kiddie tax age increased since then, and new regulations took effect in 2018 and changed again in 2020. “Over time, the scope of who is subject to tax has increased and it can now apply to dependents up to the age of 18 and college. Students aged 19 to 23,” Sarah Shannonhouse, manager of the American Institute of CPAS The tax calls for practice and ethics.
What is a kiddie tax?
“Kiddy tax” is a tax on a child’s unearned income. “If the child’s undisclosed income exceeds $ 2,200, he is subject to the kiddie tax,” says Michael Trunk, CPA’s Irvine and a personal financial expert at the company’s LTA in California. The child’s unearned income comes from sources other than work. For example, the child may investment income Receive unearned income from custodial account, or inherited IRAs And taxable scholarship, says Trank.
A child’s investment and other undisclosed income in excess of $ 2,200 is subject to Kiddie Tax Rules and is taxed at the parent’s rate. The kiddie tax does not apply to any salary or wages of working, which is levied at the rate of a child.
How is kidney tax calculated?
Under Kiddy Tax Rules for 2020, a child’s unearned income is not taxed under $ 1,100; The next $ 1,100 is taxed at the child’s tax rate and any unearned income over $ 2,200 is taxed at the parent’s tax rate.
“The child could File tax return, Or parents may be able to make choices to report their child’s interests, simple dividends, and capital gains distributions. Either way, the income will be taxed at the marginal tax rate of the parents, ”says Manderfield.
When a child is required to file a separate tax return
The rules for filing a separate tax return depend on how much the child earned from working and how much the investment was from income.
Children who earned more than $ 12,400 in income in 2020 – from both earned and unearned income – must file their own income tax returns. If the child’s sole income is less than $ 11,000 from interest, dividends and capital gains distributions and totals, the parent may be able to include the child’s income in their tax returns. Form 8814. There are some other requirements for a parent to qualify for inclusion in a tax return, with no withholding or anticipated prepayment for the child, if not a full-time student and child if the child is less than 19 or 24 years old Must be less than. File a joint return with a spouse, Trunk says.
There are pros and cons to reporting a child’s income upon parent’s return if eligible. “The benefit is convenience, but it also has disadvantages such as potentially exposing a child’s income to a net investment income tax, a child’s loss itemized deductions And a slight increase in the tax on capital gains and qualified dividends, ”says Trank.
Remodeling the 2018 and 2019 kiddie tax returns
Kiddi tax rules temporarily changed in 2018 and 2019 Tax Deduction and Jobs Act, Kiddie was based on tax Tax rates Which applies to estates and trusts rather than the tax rate of the child’s parents. “As a result, there was a time period from 2018-19 where dependents could be subjected to kiddie tax rules, possibly taxed at rates higher than their parents’ marginal tax rate,” Shannonhouse says .
In late 2019, another law was enacted that changed the kidney tax back to the parental rate. Parents who used the property-tax rate in 2018 and 2019 have the option to amend their income tax returns and use the parent rate. “For 2018 and 2019 returns, taxpayers can choose to use either property tax rates or parental tax rates to calculate kidney tax,” Shannonhouse says. “For 2020 and beyond, parental tax rates apply.”
You have until three years after the last date for filing taxes. Modify return. “In deciding the amendment, parents must do an analysis to compare the results and to determine if there is a substantial benefit in time and cost to determine,” Trank says. “If the parent is in the middle or lower brackets, the amendment can save taxes.”