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The Kiddie Tax: Reverting to Prior Law

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As the Tax Cuts and Jobs Act (TCJA) was enacted to simplify tax calculations, one area where such simplification was welcomed was the so-called “kiddie tax.” The kiddie tax was originally created to prevent wealthy parents from shifting income to their children to benefit from their lower tax rate, in order to decrease the overall family tax burden. Prior to December 31, 2017, the kiddie tax calculation involved taxing a child’s unearned income over $2,100 at the parents’ tax rate. This was often a complex calculation, only to be further complicated when there were multiple children in the family. Under the TCJA, the kiddie tax applied to the child’s unearned income over $2,100 at the same tax rates as estates and trusts.

While the kiddie tax is undoubtedly easier to calculate under TCJA, with the new tax brackets for trusts and estates unearned income reaches the top marginal rates much faster. Families already subject to the top tax rate generally fare better or the same under the new kiddie tax calculation. However, middle- to low-income families are at a disadvantage because children reach the highest tax bracket at more compressed income, and it is likely that a child’s income will now be subject to a rate higher than their parents’.

Another unintended consequence of the new rule is the taxing of military survivor benefits, Alaska permanent fund dividends, tribal funds for Native American children, and scholarships used for expenses other than tuition and books. The first legislative remedy came from the Senate on May 21, 2019. The Gold Star Family Tax Relief Act reclassifies survivor benefits as earned income subject to regular tax rates, for 2018 and going forward. Any taxpayer who has already filed a 2018 return has the option to amend their tax return to reflect this change.

However, as the voices of other affected groups echoed louder, lawmakers sought to find a more sweeping solution. On May 23, 2019, the Setting Every Community Up For Retirement Enhancement (SECURE) Act of 2019 was passed by the House of Representatives. This act completely repeals the 2017 changes to the kiddie tax under TCJA, restoring the original rules, effective with tax years starting in 2019. For 2018, taxpayers have the option of computing the kiddie tax under both pre-TCJA and post-TCJA rules and filing their returns using whichever method is more advantageous.

The changes to the kiddie tax in the last few weeks have been the first to revert to tax law in place prior to the TCJA. Because the TCJA was passed in such a short timeframe, before the beginning of the 2018 tax filing season, we have yet to see all of the consequences of the new law. Senator Charles E. Grassley of Iowa, who worked on correcting the kiddie tax issue, further affirms this sentiment by saying, “Historically, after major tax legislation, the longstanding practice has been to correct drafting errors and other technical issues on a bipartisan basis.”

The kiddie tax was merely the first. As time progresses and we see how the TCJA plays out for other tax issues, additional modifications to tax law can be expected.

 
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