New kiddie tax worksheets: Optional election to use parent’s rate

New Form 8615 Instructions reflect SECURE Act changes and give an optional calculation using the parent’s rate to figure kiddie tax.

February 19, 2020

The IRS revised instructions to the 2019 Form 8615, Tax for Certain Children Who Have Unearned Income to accommodate changes made by the SECURE Act of 2019. For tax years 2018 and 2019, taxpayers may figure the kiddie tax two different ways and select the most beneficial method.

Kiddie tax background

The unearned income of children is subject to a special calculation known as the “kiddie tax.” Unearned income may include investment income, some taxable scholarships, pension distributions, unemployment income, and more. The kiddie tax calculation applies to a child who:

  • Has more than $2,200 of unearned income (for 2019) and a tax return filing requirement, and
  • Is either:
    • Under age 18
    • Age 18 unless more than one-half support is provided by the child’s own earned income, or
    • Age 19-23 and a full-time student unless more than one-half support is provided by the child’s own earned income, and
  • Has at least one living parent, and
  • Does not file a joint return.

The purpose of the kiddie tax was to prevent parents from lowering their own tax bills by transferring assets, such as dividend paying stocks, to their children who would presumably pay tax at a lower rate. Prior to the TCJA, children’s net unearned income over a certain threshold was taxed at their parents’ tax rates. Under the TCJA, starting in 2018, net unearned income over the threshold ($2,100 for 2018 and $2,200 for 2019) is taxed using the rates and brackets that apply to estates and trusts.

The SECURE Act repeals the TCJA change starting in tax year 2020. For tax years 2018 and 2019, taxpayers may use the trust rate calculation or elect to apply the parent’s rate calculation. Starting with tax year 2020, the trust rate calculation is no longer available.

Note: Another change made by the SECURE Act is that the special AMT exemption for children subject to the kiddie tax is suspended retroactively to 2018. That is, the AMT exemption for children subject to kiddie tax is the same as the exemption for all individuals. See the Instructions to Form 6251, Alternative Minimum Tax-Individuals. We will cover this change in next week’s TAX in the News.

Figuring the kiddie tax: Two options

According to the Form 8615 instructions, taxpayers will complete the tax computation for line 7 differently depending on which calculation method they choose:

  • The 2019 Line 7 Tax Computation Worksheet figures the tax based on brackets and rates for estates and trusts (the default calculation).
  • The 2019 2019 Tentative Tax Based on The Tax Rate of Your Parent Worksheet uses the election to determine tax based on the parent’s rate.

Taxpayers who use the optional calculation should include the statement “election to modify tax of unearned income.” The statement may be shown on top of Form 8615 or next to line 7 or on an attachment to the tax return.

Example: Morris and Doreen Pearl live with Doreen’s two children, Harry and Jane Barnatt, ages 14 and 18 respectively. In 2019, Morris’s only income was $10,000 in Social Security disability benefits, of which $2,500 is taxable. Doreen had $32,000 in wages. Unexpectedly, the children’s father (Doreen’s ex-husband) passed away and each child received a $6,000 payout from his annuity. Their unearned income is subject to the kiddie tax.

The Pearl’s 1040, Jane’s 1040, Jane’s Form 8615 and related worksheets are linked here. In this case Harry’s Form 1040, Form 8615, and worksheets would be identical to Jane’s.

Comparing calculation alternatives, the default calculation (taxed at trust rates) results in kiddie tax of $658 per child while the optional election (taxed at parent’s rate) results in kiddie tax of $490 per child, a difference of $168 per child.

The main difference in the two calculations is that for the calculation using trust rates, $1,200 of each child’s unearned income is taxed at 24% whereas for the calculation using the parent’s rates it is taxed at the parent’s rate of 10%. Thus, the alternative calculation yields a savings of $168 [$1,200 × (24% - 10%)] for each child and $336 for the family.

Clearly the calculation at the parent’s rate is the better choice for this family but that is not necessarily the case for everyone. For instance, if the Pearls were in the 37% marginal tax bracket the calculation at trust rates would probably result in a lower tax bill.

Other considerations for the kiddie tax optional calculation

Other points to consider about the kiddie tax:

  • Capital gain and other calculations. Additional calculations are needed if qualified dividends, net capital gain, farm income averaging (Schedule J), or the foreign earned income exclusion (Form 2555) are involved. See the Form 8615 instructions.
  • Dependent or not. The rules about who is subject to kiddie tax are similar, but not identical to the rules about who is a dependent qualifying child or qualifying relative. A child who is largely supported by unearned income may not be a dependent but subject to the kiddie tax. Example: A 20-year old college student getting a survivor’s pension, Social Security survivor’s benefits, and unemployment income may be self-supporting but still pay kiddie tax.
  • Amending 2018. Taxpayers who filed a 2018 tax return using the trust rate calculation may amend to use the optional calculation. They would use the 2018 Form 8615 and instructions. As of February 18, 2020, the 2018 version of Form 8615 instructions is currently in draft and expected to be released soon.

Originally published in the 02/19/2020 edition of TAX in the News.

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