Parents of young children will always have plenty to worry about. New tax legislation passed at the end of 2019 eliminates at least one of these worries. The new law repeals a provision that increased the tax a child had to pay on unearned income.
Best of all, these revised "kiddie tax" rules may be claimed retroactive to 2018, when the change initially took effect. It’s as if it never happened!
The kiddie tax rule
If a dependent child under age 19 or a full-time student under age 24 receives unearned income above an annual threshold, the amount of income above this threshold is generally subject to a higher tax. Unearned income includes income received from investments, dividends and interest income.
The annual threshold, which is indexed for inflation, is $2,200 on 2019 and 2020 tax returns.
Children's unearned income above this $2,200 threshold was historically taxed at the parents', usually higher, tax rate.
The (often painful) change
Through the 2017 tax year, a child’s unearned income avoided the parents’ top marginal rate of 37% as long as the parents’ taxable income didn’t exceed $500,000. In 2018, kids got ensnared in the 37% top tax rate after their own unearned income hit $12,500!
The result? Many kids paid significantly more taxes in 2018 because of the new kiddie tax rules.
What you need to know
New legislation now restores the old method of calculating the kiddie tax. The tax is once again based on the parents’ marginal tax rate. But more importantly, you can choose to have the fix apply to 2018 and 2019. While this change will be reflected in your 2019 tax return, you may need to review your 2018 tax return to see if it makes sense to file an amended return.
The good news is you have some time to make this decision while you focus on getting ready to file this year's tax return.
As always, feel free to pass this Tip along to friends, and reach out if you need help with your personal tax and finance situation.