The 2017 tax act (Pub. L. No. 115-97) made a significant change to the “Kiddie Tax,” which may or may not affect your client’s planning when dealing with UGMA or UTMA accounts.
If you are not familiar with an UGMA or UTMA account, they are accounts that make it simple to transfer property to your children. An UGMA account generally permits only the transfer of securities, money, insurance policies, and annuity contracts, while an UTMA account is generally permits the transfer of any type of property, real or personal, tangible or intangible. Any income from either account is attributable to the child and, thus, subject to the Kiddie Tax rules under §1(g).
The Kiddie Tax applies to the net unearned income of a child, regardless of the source of the property that generates the income. Unearned income is income that is not attributable to earned income, which generally includes wages, salaries, professional fees, and other amounts received for personal services rendered. The child must be under the age of 19 or a full-time student under the age of 24. Additionally, the unearned income of the child must be over $2,100.
For both 2017 and 2018, the child’s unearned income over $2,100 continues to be subject to the Kiddie Tax. However, the 2017 tax act changed the marginal tax rates applicable to the unearned income of a child to the ordinary and capital gains rates applicable to trusts and estates for tax years after 2017 and before 2026.
Therefore, for tax years beginning after 2017 and before 2026, a child's earned income is taxed at the unmarried taxpayer's rates, and a child's unearned income is taxed at the ordinary and capital gains rates applicable to trusts and estates. Prior to 2018, the marginal tax rate of the parent(s) was used to calculate the child's tax.
The application of income tax rates of trusts and estates to the unearned income of children may be advantageous depending upon whether the children will have substantial unearned income and whether the parents of the children are in higher income tax brackets. For example, where a child has $2,500 of unearned income and the parents are in the 24% income tax bracket, the child receives the advantage of being taxed at the 10% tax rate applicable to trusts and estates, rather than the 24% tax rate applicable to the parents. On the other hand, the tax brackets for trusts and estates are far more compressed, which means the same child with $11,500 of unearned income will be taxed up to 35%.
This significant change adds another consideration when determining whether and to what extent an individual may consider passing income to his or her children. The parents should continue to consider contributing to §529 plans, using the annual exclusion amount, and, if the parents own a small business, having the children work, as earned income is not subject to the Kiddie Tax. Although the new tax brackets for the Kiddie Tax may or may not impact your client’s planning with regards to UGMA or UTMA accounts, it is important to understand and review the change to the Kiddie Tax to better inform your client on the advantages and disadvantages of the change.
For everything necessary to research, plan, and implement strategies for maximizing your clients’ control while minimizing taxes, take a free trial to the Estates, Gifts and Trusts Portfolios Library.
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