03.24.21

Tax Connections Newsletter – Winter 2021
Robert Swenson

The Kiddie Tax, Working Remotely and Other Tax News

Congress does a 180 on the kiddie tax

The “kiddie tax” was established in 1986 to discourage people from avoiding taxes by shifting income to their children in lower tax brackets. It achieved this goal by imposing tax at the parents’ marginal rate on most of a child’s unearned income, such as interest or dividends from investments. Under the Tax Cuts and Jobs Act (TCJA), however, beginning in 2018 this income was subject to tax at the rates applicable to trusts and estates. Because the highest tax rates for trusts and estates kicked in at low-income levels (between $12,000 and $13,000), this meant that the kiddie tax rate was often higher than the parents’ marginal rate.

In late 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act restored the pre-TCJA rules. The Act also provided that taxpayers may choose between the TCJA and SECURE Act rules for the 2018 and 2019 tax years. If your children paid kiddie tax for those years, it pays to review those returns and amend them if the alternate computation would result in a lower tax bill.

Generally, the kiddie tax applies to children under age 19 (for full-time students, age 24) as of the last day of the tax year. It does not apply to children who are married and file joint returns, or age 18 or older with earned income that exceeds half of their living expenses.

Related Read: What Was Old Is New Again With the “Kiddie Tax”

Working remotely? Watch out for double taxation

This year, many people have been working remotely, in some cases in a different state than the one they usually work in. If you have been working remotely across state lines, investigate the potential impact on your state tax bill. You may find yourself with two states attempting to tax the same income: The state where your employer is located and the one where you are residing and working. Many states, but not all, offer credits for taxes paid to other states, so ask your ORBA tax advisor about this.

Reporting paid sick and family leave

The Families First Coronavirus Response Act requires employers with fewer than 500 employees to provide paid sick leave or family and medical leave to employees who miss work for specified reasons related to COVID-19. An IRS Notice provides guidance on how employers should report these payments.

According to the notice, employers may report payments on Form W-2, box 14, or in a separate statement. Either way, an employer must separately state the total amount of:

  1. Qualified sick leave wages paid because the employee was quarantined or diagnosed with COVID-19;
  2. Qualified sick leave wages paid because the employee was caring for a family member; and
  3. Qualified family leave wages.

Related Read: What You Need to Know About the Families First Coronavirus Response Act

Using qualified small business stock to attract investors

For businesses in need of funding, qualified small business stock (QSBS) can be a powerful tool for attracting investment capital. It entices investors with the prospect of tax-free gains on the sale of the stock (subject to certain limitations), provided they hold it for more than five years. Generally, to qualify, stock must be issued by a domestic C corporation that has aggregate gross assets of $50 million or less, must not be involved in certain types of business (for example, professional services, banking, insurance, farming, oil and gas or hospitality), and must meet several other requirements. Among other things, the stock must be acquired by investors as part of an original issuance rather than from other shareholders.

Related Read: QSBS Offers Remarkable Tax Breaks

Pass the SALT

Since 2018, individuals have been subject to a $10,000 limit on itemized deductions of state and local taxes (SALT). Until recently, however, it was uncertain whether that limit applies to entity-level taxes incurred by pass-through entities — such as S corporations, partnerships and limited liability companies — and passed through to their individual owners. Recently, the IRS announced its intent to issue regulations confirming that these taxes are not subject to their owners’ $10,000 SALT deduction limit. Although it is not yet clear how the final regulations will work, the announcement appears to endorse a workaround to the $10,000 limit, adopted in some states. These states have imposed entity-level taxes on pass-through businesses, with the business owners receiving a corresponding tax credit or exemption.

Reducing taxes with net gifts

A “net gift” can be an effective tool for reducing gift taxes. It is simply an agreement by the donee, as a condition of receiving the gift, to pay any resulting gift tax. This liability reduces the value of the gift, thereby reducing the tax. A “net, net gift” can reduce the tax even further. Here is how it works: In addition to agreeing to pay the gift tax, the donee also assumes liability for any estate tax that might arise if the donor dies within three years of making the gift. Under the “three-year rule,” gifts made within three years of death are included in the donor’s estate. The actuarial value of this potential liability reduces the value of the gift.

Want to save taxes? Hire your kids

For business owners, hiring your children can be a great tax-saving strategy. By shifting income to family members in lower tax brackets, you can reduce your family’s overall tax bill. Plus, if your kids are under 18, they are exempt from Social Security and Medicare taxes if the business is either a sole proprietorship or a partnership in which you and your spouse are the only partners.

For more information, contact Rob Swenson at rswenson@orba.com or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.

Forward Thinking