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February 16, 2018 at 11:34 AM
The 2017 Tax Act makes a number of changes that may be significant for taxpayers who support children or other dependents. The questions below explore the effects of the new act in five such areas.
1. How does tax reform impact the treatment of unearned income of minors, or the so-called “kiddie tax”?
Under prior law, children under the age of nineteen (age twenty-four for students) were required to pay tax on their unearned income above a certain amount at their parents’ marginal rate. The so-called “kiddie tax” applies to children who have not attained certain ages before the close of the taxable year, who have at least one parent alive at the close of the taxable year, and who have over $2,100 (in 2015-2018) of unearned income.
The kiddie tax applies to:
- a child under age eighteen; or
- a child who has attained the age of eighteen if (i) the child has not attained the age of nineteen (twenty-four in the case of a full-time student) before the close of the taxable year; and (ii) the earned income of the child does not exceed one-half of the amount of the child’s support for the year.
The tax applies only to “net unearned income.” “Net unearned income” is defined as adjusted gross income that is not attributable to earned income, and that exceeds (1) the $1,050 standard deduction for a dependent child in 2018, plus (2) the greater of $1,050 or (if the child itemizes) the amount of allowable itemized deductions that are directly connected with the production of his unearned income.
The 2017 Tax Act aims to simplify the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. Therefore, earned income of minors will be taxed according to the individual income tax rates prescribed for single filers, and unearned income of minors will be taxed according to the applicable tax bracket that would apply if the income was that of a trust or estate (for both income that is subject to ordinary income tax rates and in determining the capital gains rate that will apply if long-term capital gains treatment is appropriate).
The rates that will apply to trusts and estates under the 2017 Tax Act are as follows:
| Tax Rate |
Trusts and Estate Income |
| 10% |
$0 to $2,550 |
| $255 plus 24% of the excess over $2,550 |
$2,550-$9,150 |
| $1,839 plus 35% of the excess over $9,150 |
$9,150-$12,500 |
| $3,011.50 plus 37% of the excess over $12,500 |
Over $12,500 |
This provision does not apply to tax years beginning after December 31, 2025.
Planning Point: Because the unearned income of minors was previously taxed at a parent’s tax rate, this means that a child with a relatively small level of unearned income may pay less on this income (a child can essentially have up to $4,650 in unearned income before he or she moves out of the lowest 10% tax bracket–$2,100 that is exempt and $2,550 taxed at the 10% rate).
However, the minor will also jump into the highest tax bracket more quickly under the new law. While the minor’s parents will not be taxed at the 37% rate until their combined income for the year exceeds $600,000 (assuming a joint return), the child will be taxed at that rate once he or she has unearned income in excess of only $12,500. As a result, some parents may wish to consider taking steps to reduce the child’s taxable income (i.e., by keeping any funds invested until the child is no longer subject to the kiddie tax rules).
2. Does tax reform impact any personal tax credits other than the child tax credit?
Most of the personal tax credits were not impacted by tax reform. This includes the credit for the elderly and permanently disabled, adoption credit, the American Opportunity tax credit, Lifetime Learning tax credit, and the saver’s credit
3. How does tax reform impact the treatment of alimony payments?
The 2017 Tax Act eliminated the previously existing above-the-line deduction for alimony for tax years beginning after 2018, and provides that alimony and separate maintenance payments are no longer included in the income of the recipient.
This provision is effective after December 31, 2018, but also applies to divorce or separation agreements executed before that date that are subsequently modified and specify that the new provision will apply.
Planning Point: This new rule means that alimony payments will no longer be considered compensation for purposes of IRA contributions, which could impact an alimony recipient’s ability to contribute to an IRA absent further guidance to the contrary.
