One part of the Tax Cuts and Jobs Act that has not received a lot of attention is the change of calculation for the so-called “kiddie tax”. This tax applies to children who have unearned income in excess of $2,100. The kiddie tax applies to children age 18 and under or age 19-23 for full-time students whose earned income is less than or equal to 50% of their support.
Under the old law, unearned income in excess of $ 2,100 was taxed at their parent’s income tax rate but the new law subjects this income to the same rates as a trust. As a result, unearned income would hit the top tax rate of 37% at the very low income level of $ 12,500. The parent’s rate would only be that high if the parent’s income is over $ 600,000. Therefore, the strategy of grandparents leaving a grandchild a traditional IRA, with the goal of achieving a longer distribution period may not be as attractive as it used to be.
Given this new reality, what can be done to work around the “kiddie tax”?
- You can still gift modest amounts to children in UTMA accounts and keep their investment income below $2,100 by investing in growth stocks vs. dividend payers.
- If a college age child has already inherited a large IRA, then reduce their distributions to the minimum required, borrow money to cover tuition and then pay off the debt with larger distributions once the child turns 24.
- Name older children (age 24 and above) as beneficiaries of your traditional IRAs. Younger children could still be beneficiaries of Roth IRAs.
Leaving traditional IRAs to children or grandchildren is still a viable strategy but care must be taken to avoid or minimize the kiddie tax.
David K. Raye, CPA, P.C. 704-887-5298 www.davidrayecpa.com
*The information in this blog post is general in nature and not intended as specific advice. Please consult a tax advisor to see how this information applies to your specific situation.
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