The tax kids pay is impacted by the SECURE Act

On Dec. 20, President Trump signed the SECURE Act. The new law is mainly intended to expand opportunities for individuals to increase their retirement savings.

This had an impact not only retirees, but on a wide range of taxpayers. One of the big ones is an easing of the dreaded Kiddie Tax rules that can penalize investment income collected by children and young adults. And you may want to pay attention: it may apply to your 2018 tax return.

The “Kiddie Tax” is assessed on a child’s unearned income (think interest, dividends, capital gains, etc.) over a threshold amount. That amount is $2,200 for 2019 and 2020. The tax applies to dependents if they are under 19 or full-time students between 19 and 23.

The Secure Act basically undoes a change to the Kiddie Tax rules that was part of the 2017 tax overhaul. Previously, the Kiddie Tax taxed a portion of an affected child unearned income (think investments) at the parent’s marginal rate when that rate was higher than what the child would otherwise pay. But the 2017 Tax Cuts and Jobs Act taxed a portion of the unearned income at the rates that trusts and estates pay, which could make the tax significantly higher.

Trump made sure that the Secure Act retroactively reverts to the old rules.

The Formula

To go back in history, this has been in place since 1986 to discourage families from holding investments in their children’s name to avoid tax. Before the Tax Cuts and Jobs Act (TCJA) passed in 2017, it was calculated using the parents’ marginal tax rate. In an effort to simplify reporting, TCJA changed the law starting for 2018 to instead apply trust and estate tax rates. This meant their 2018 returns could be filed early in 2019 instead of waiting for their parents’ returns to be done.

And the formula to calculate it is:

Child’s Net Earned Income + Child’s Net Unearned Income – Child’s Standard Deduction = Child’s Taxable Income

The SECURE Act has now established that starting for 2020, the law will revert to using the parents’ marginal tax rate. For 2018 and 2019 tax years, taxpayers have the option to either apply trust and estate rates or go back to the marginal rates. So depending on the situation, it could be beneficial to amend a 2018 return if you have already filed.