WTOP Interview: 4 Ways the Kiddie Tax Can Work for You and Your Family
Shawn Anderson: It is 5:11. The new tax cuts and Jobs Act introduced many tax reforms that can have advantages for taxpayers, even children. The so-called kiddie tax is one area you might think about paying attention to if your kids have earned and unearned income.
Dawn Doebler: Thank you, Shawn.
Shawn: Can you start just by telling us what is the kiddie tax?
Dawn: Yes. So, we wrote this article because this tax often really gets a bad rap and we want to emphasize to listeners, that there are still some income shifting strategies that can be powerful tax savings tools; especially when you take them over a period of years. So, the kiddie tax was first applied in 1987. And it was inactive to prevent wealthy parents from shifting income to children in lower or zero tax brackets. It does apply to income of children under age 18 or full-time students, aged 18 to 24 who are claimed as dependents. And an unearned income is really any source of income not from labor. Some examples are interests, dividends, taxable scholarships not reported a W-2, or unearned income received as a beneficiary of a trust.
And the original kiddie tax rules, say that if children have unearned income over a certain amount that’s $21,000 in 2018, that additional income is taxed at the parent’s top marginal tax rate. And in recent tax law, the kiddie tax works similarly but they did change the tax rate that applies and now they use the same tax rate as estates and trusts, rather than using the parents’ tax rate.
Shawn: And are there other strategies that moms and dads should know about that could help when tax time rolls around?
Dawn: Well, if you have children, we suggest you go to the article. I think the best idea we have in there is providing tax-free earned income to your children and getting to kids tax-free earned income is easier now under the new tax law because of the increase in the standard deduction. In 2018, if you pay your child a wage that falls below the $12,000 standard deduction, that income is nontaxable to the child. So, this idea is best used by parents who own a business and who also fall into a very high tax bracket; it requires you to find some actual work for your children to do in your business. So, you may need to wait until they’re old enough to meet a reasonableness test, but some creative ideas we’ve seen are having children answer phones, sort paperwork or otherwise provide help in your business.
And in a nutshell, the benefit is if your profits are left in the family business, the income might be taxed at a rate as high as 37% and maybe even 3.8% higher if that tax applies. So, instead, if you pay wages to a child, you could shelter up to $12,000 of income tax-free.
Shawn: Okay. Maybe, in 30 seconds here; if you have a child that has unearned income, what can a parent do to reduce some of those taxes?
Dawn: Well, the goal here is to manage your children’s unearned income to hit below that $21,00 kiddie tax limit. So, first, check how you’re investing assets in your children’s names, see if it makes sense to invest in things like equity mutual funds or tax-exempt bonds, so that earnings are qualified dividends or long term capital gains, rather than interest income that’s taxed at higher rates. And stay aware of the kiddie tax rules because they do change. There’s a lot more information on the new tax law and more planning techniques in our article. So, please go check that out for more information.
And you can read all that on wtop.com.