Lawmakers Are Working to Fix Unexpected Tax Increases for Gold Star Families

With the remembrance of the country’s fallen heroes this past Memorial day, Congress is continuing to work on passing a change to the new “kiddie tax” rules affecting Gold Star families, under the Tax Cuts and Jobs Act (TCJA). Gold Star families are immediate relatives of U.S. armed forces members who died in battle or in support of certain military activities.

Background

Like all individual taxpayers, children can receive two types of income: earned income and unearned income. Earned income is derived from goods sold, services rendered, and work performed. The common types of earned income include, but are not limited to, wages, commissions, and bonuses. Unearned income is an individual’s income derived from sources other than employment. Common types of unearned income include, but are not limited to, interest, dividends, capital gains and capital gain distributions, and the taxable portion of social security and pension payments. The kiddie tax is a federal tax that is levied on the portion of a child’s unearned income that exceeds $2,100.

Certain conditions subject a child to kiddie tax:

1. The child has unearned income in excess of $2,100;
2. The child meets one of the following age requirements:
1. They are under age 18 at the end of the tax year,
2. They are age 18 at the end of the tax year and did not have earned income representing more than half of their support, or
3. They are a full-time student at least age 19 and under age 24 at the end of the tax year and did not have earned income representing more than half of their support.
3. At least one of the child’s parents was alive at the end of the tax year;
4. The child is required to file a tax return for the tax year; AND
5. The child does not file a joint return for the tax year.

TCJA Changes

Prior to the Tax Cuts and Jobs Act, the kiddie tax rate was equal to a child’s parents’ highest marginal tax rate, which in 2017 ranged from 10% to 39.6%. Under the new law, in an effort to simplify the calculation, the kiddie tax rate is no longer dependent on the parents’ rate. Instead, unearned income that is payable to a child is taxed at the same rates as trusts and estates, which could climb as high as 37%. Earned income payable to children is taxed at the same rates as a single individual taxpayer.

Currently, Gold Star families can receive two types of monthly payments:

1. Dependency and Indemnity Compensation
1. This is issued by the Department of Veteran Affairs.
2. It is a tax-free monetary benefit paid to eligible survivors of service members who either died in the line of duty or from a service-related injury or disease.
2. Survivor Benefit Plan
1. This is issued by the Department of Defense.
2. It is a lifetime annuity, paid to an eligible beneficiary, based on percentage of pay, adjusted for inflation.

Families who receive both benefits are currently subject to the “widow’s tax,” meaning the amount of the Survivor Benefit Plan issued by the Department of Defense is offset by the amount of Dependency and Indemnity Compensation received from the VA. They cannot receive the full amount of these benefits simultaneously. As a work–around to this conundrum, surviving spouses often put the Survivor Benefit Plan in their children’s names in order to receive the full amount of both benefits at the same time. These payments become subject to the kiddie tax.

Prior to tax year 2018, since these benefits were taxed at the parent’s highest marginal tax rate, the tax consequences were the same as if the surviving spouse were receiving the benefits. However, under the new law, these benefits are currently classified as unearned income. As a result, the income is taxed at the same rates as trust and estates. Although trusts and estates have a similar tax bracket as individuals, trust and estates reach the highest tax bracket of 37% at a much faster rate, only needing taxable income over $12,500 to reach the highest bracket. A single individual, on the other hand, would need taxable income above $500,000 in order to reach the highest tax bracket. This has resulted in some Gold Star Families seeing their tax bills increase significantly from the 2017 tax year.

In order to eliminate these tax increases on military survivors, the Senate proposed the “Gold Star Family Tax Relief Act,” which would treat survivor benefits as earned income, rather than as unearned income, enabling them to be taxed at a lower rate. The bill was approved by unanimous consent on May 21, 2019.

The House of Representatives also recognized a need for a fix to the taxation of survivor benefits, incorporating its version within a bill referred to as the “Setting Every Community Up for Retirement Enhancement Act of 2019” (SECURE Act). The SECURE Act was approved by the House on May 23.

When the Senate agreed on the “Gold Star Family Relief Act” there were hopes that the House would propose a similar bill that would reach the President to sign into law before the Memorial Day recess. However, the Senate and House were unable to reconcile their bills in time. Since Congress has returned from the Memorial Day recess, there have been no updates reported on progress as of this writing. Marcum will keep all readers up to date on any changes to these rules.

For more information about the changes to the kiddie tax under the Tax Cuts and Jobs Act, please contact your Marcum tax advisor.