Kiddie Tax Computation

[slowreader]

Okay! One has to use the Step-by-Step, and then (and only then) does the question pop up: Do you wish to use the pre-TCJA rules?, or some such language. I click yes, and the next question is the parents' taxable income, and we are off to the races. Thank you, Inuit!

I hope TurboTax will make it as easy to file a 1040X for 2018....

[slowreader]

Sorry, I meant to say "Intuit"!

[Debra56]

The first $1100 is not taxed (standard deduction).

The next $1100 is taxed at the child's single rate which is 0% for a LTCG or Qual Div.

The Estate & Trust rates are applied next.  The first $2600 is taxed at 0% for a LTCG or Qual Div. 

From $2601 to $12,950, it jumps to 15%, and at $12,951, the rate increases to $20% and an additional 3.8% NII tax kicks in.

[tax_curious1]

$2650 in 2019 -- just to get the right numbers.

[slowreader]

@Debra56 

You don't have to use the Trust tax rates if the parents' tax bracket are more favorable, as they are in the case of most "gold star" children (who receive money in partial compensation for parents killed in line of duty) and many college students (whose grandparents may have gifted assets to them as they were growing up). In a typical case, parents' capital gains are taxed at zero up to $39,375 - $78,750 depending on filing status, whereas the zero rate is limited to $2,650 in the Trust rates. Now think of the tax hit on a young woman who sells enough stock to pay for a year of college!

The 2019 TurboTax has been updated to provide the alternative and in many cases more favorable method of filling out Form 8615, but the 2018 edition has not.

[tax_curious1]

many people are talking about the advantages of not using the trust rates

but i bet there are  many people who will find it advantageous this year

to use the trust rate method .. and nobody seems to be talking about that...

[slowreader]

I doubt that its "many". You'd have to be taking in $500,000 a year before you'd pay taxes at the rates assessed on a 20-year-old college student with "unearned" income of $32,000, about a third the cost of year at an Ivy after transportation, health insurance, and $5000 Federal income tax.

You'll find out next year, when the "alternative" becomes mandatory.

[andrewF]

I think if parents are paying taxes on qualified dividends at 15% (ordinary income between $78,751-$488,850, a pretty broad range), then the TCJA rules are more favorable for a wide range of children's qualified dividend income.

This is my understanding:

Both TCJA rules and pre-TCJA rules have an $1100 standard deduction, with the next $1100 taxed at the child's rate. The rules start to differ above $2200 of unearned income.

TCJA (estate rules):

$0-$2650 (above the first $2200): 0%

$2651-$12950: 15%

$12951+: 20%+NIIT

pre-TCJA:

all of this is taxed at 15% (+NIIT if the parents are at or kicked above the threshold for that)

I'm not an accountant so if anyone has any corrections for the above I'd be happy to hear it. But it seems the TCJA rules will be the same as pre-TCJA rules for those under $2200, and the TCJA rules will be favorable for most people with children's unearned income between $2200 to something north of 2200+12950. 

If I understand properly, re-TCJA rules are advantageous for children whose parents have ordinary income under $78,750, or for those with unearned income more like the $32000 example given earlier (I haven't done the math to figure out where the 20% estate rate costs more than the savings at 0-2650).

[justataxnerd]

the $3,750 of tax free qualified div/ lt capital gains is essentially based on TCJA (pre-SECURE Act) kiddie tax rules that require you to use trust tax brackets for the tax calculation of kid's unearned income.

Trusts have the following QDCG tax rates:

0%  ... 0 - 2,650 

15% ... 2,651 - 13,150

20% ... 13,151 +

So under TCJA (before SECURE Act changed it back for 2020 onwards)

$4,850 of qualified dividends would not be taxed.  The calculation is as follows:

$4,850 of income (all qualified dividends)

-2,200 (twice the standard deduction for a dependent child with only unearned income, though the number is indexed to inflation, kiddie tax has always essentially exempted 2x the unearned income standard deduction)

---------

2,650 taxable income subject to trust tax rates. 

In other words, it all falls into the 0% tax bracket for trusts mentioned above.

SECURE Act gives the option to use the pre-TCJA rules for the kiddie tax (i.e. re-doing the parents tax return to include the kid's income and figure the tax) or continuing to use the Trust rates as TurboTax apparently programmed their system to do for 2019 tax returns. 

For 2020 and onwards, I believe using trust tax rates is no longer an option.  

Thus a kid with between $2,200-$4,850 of unearned income that is all qualified dividends or LT Cap gains, can no longer take advantage of the small sliver of a 0% trust tax rate on that type of income.    If his/her parents have taxable incomes that push all of their qualified dividends between 2,200 and 4,850 or LTCG into the 15% bracket, Congress did them no favor with the SECURE Act.

Those kids with unearned income other than QD or LTCG, on the other hand, will most likely benefit by having their income picked up at their parents rate as opposed to trust tax rates.

SECURE Act made the change retroactive giving the option to amend 2018 & 2019 returns if already filed using trust rates as req'd by TCJA.   

You can forgive tax accountants if they just were getting a hang of the implications of the kiddie tax changes only to have the switched back a couple years later to the good old kiddie tax rules.    The old way of doing things, i.e. computing tax on kids investment income as if it were taxed at parents rates, is really not a lot of fun as you can see from the new instructions to 8615 ( https://www.irs.gov/pub/irs-pdf/f8615.pdf ), especially when there are more than 1 dependents with unearned income.   

[tax_curious1]

100% agree.  

For 2020 taxes,  the SECURE computation gives no choice, and despite all the fanfare

that it's a win, it seems like it could easily be a loss for many families.

For example, the 2020 law is an obvious loss for those

with between $1100 and $3750  of unearned income as now it is being taxed and before it wasn't.

I'm also guessing if parents are in a 32% tax bracket, in many cases, the new law again is a lose.

Possibly even if  the  parents are in a 24% bracket (if the unearned income is less than $10,000 maybe, haven't done the math yet.)

When i look at the numbers, i'm surprised how people think this is a good idea for them.

[tax_curious1]

i should have said $1100 to $4850 which used to be tax free would now be taxed