This post was written by Matthew Rak.
One pitfall of gifting appreciated assets is the “Kiddie Tax.” The Kiddie Tax is designed to stem revenue losses from shifting investment income from a high tax rate donor to a low tax rate child.
The Kiddie Tax applies if:
· a tax return is required for the child,
· such child does not file jointly with his or her spouse
· either parent of the child is living, and
· at the end of the year the child is:
o under age 18,
o under the age of 19 and does not provide half of the child’s support through earned income, or
o under the age of 24 and a full-time student not providing half of the child’s support.
Young working adults who have just entered the work force will generally not be subject to the tax and will be able to receive and sell of appreciated assets at their lower tax rates.
Under the Tax Cuts and Jobs Act*, beginning in 2018 the investment income of a child subject to the Kiddie Tax, is taxed using the trust income tax brackets as follows:
If taxable income is: The tax is:
Not over $2,550 10% of taxable income
Over $2,550 but not $250 plus 24% of the
over $9,150 excess over $2,550
Over $9,150 but not $1,839 plus 35% of the
over $12,500 excess over $9,150
Over $12,500 $3,011.50 plus 37% of the
excess over $12,500
Capital gains and ordinary dividends are subject to tax at 0% if investment income does not exceed $2,600 and 15% for investment income which exceeds $2,600 but not $12,700. Note that these gain exclusion brackets are not precisely coordinated with the trust tax brackets as they were in prior years.
The “shorter” tax brackets borrowed from trusts limit the benefit of shifting investment income to a child subject to the Kiddie Tax. In fact, a higher tax could result. For example, assume a grandparent gave appreciated stock to a grandchild subject to the Kiddie Tax and the grandchild sold the shares realizing a $20,000 gain. The portion of the gain exceeding $12,500 of taxable income would be subject to the 20% capital gain rate. Unless the grandparent was in the top tax bracket ($600,000 for married couples filing jointly), the shares would have been taxed at a lower rate of 15% or less.
For more information on tax smart gifting, contact any member of our Tax, Trusts, and Estates Group.
*In years prior to 2018, the Kiddie Tax stacked the child’s investment income exceeding a threshold amount ($2,100 for 2017) on top of the parent’s income and calculated the additional tax due using the parents’ tax rate. This additional tax was then charged on the child’s tax return or could be paid on the parent’s return (IRC Section 1(g)). The Tax Cuts and Jobs Act of 2017 changed these rules, applying the trust income tax rates instead of the parents’ tax rate.