Kiddie Tax: New Hazards, New Opportunities
Adam Pechin, CPA, MST
Despite its name, the kiddie tax is far from child’s play. As a result of the Tax Cuts and Jobs Act (TCJA), children with unearned income may find themselves in a higher tax bracket than their parents. At the same time, the TCJA also creates new opportunities for family income shifting.
Income shifting discouraged
At one time, parents could substantially reduce their families’ tax bills by transferring investments or other income-producing assets to their children in lower tax brackets. To discourage this strategy, Congress established the kiddie tax in 1986. The tax essentially eliminated the advantages of income shifting by taxing all but a small portion of a child’s unearned income at his or her parents’ marginal rate.
When the kiddie tax was first enacted, it applied only to children under 14, but in 2007 Congress raised the age threshold to 19 (24 for full-time students). Note that the kiddie tax does not apply to children who reach 19 (or 24, if applicable) by the last day of the tax year. In addition, the tax does not apply to children who either 1) are married and file joint returns, or 2) are 18 or older and have earned income that exceeds half of their living expenses.
Tax bite bigger
Starting in 2018, the kiddie tax applies according to the tax brackets for trusts and estates, rather than the parents’ marginal rate. In previous years, the kiddie tax essentially undid the benefits of shifting investment income to one’s children. By applying the parents’ marginal rate to that income, the tax result was about the same as if the parents had retained ownership of the assets. But, the TCJA’s approach can push children into a higher tax bracket before their parents in many cases. That is because the highest marginal tax rate for trusts and estates — currently, 37% — kicks in when taxable income exceeds $12,500. For individuals, that rate does not apply until taxable income reaches $500,000 ($600,000 for joint filers).
Suppose that a married couple filing jointly has taxable income of $250,000 per year, placing them in the 24% tax bracket. If they transfer investments generating $30,000 in ordinary taxable income to their 17-year-old daughter, she is taxed as follows:
Assuming she has no earned income, the first $1,050 is tax-free and the next $1,050 is taxed according to the regular individual income tax rate (10%, for a tax of $105). The remaining $27,900 is taxed at the rates for trusts and estates. In 2018, that means the first $2,550 is taxed at 10% ($255 in tax), the next $6,600 is taxed at 24% ($1,584 in tax), the next $3,350 is taxed at 35% ($1,172.50) and the remaining $15,400 is taxed at 37% ($5,698), for a total tax of $8,814.50. Had the parents retained the investments, the tax would have been $7,200 ($30,000 × 24%). In other words, income shifting increases the family’s tax bill by more than $1,600.
Note that the calculation of the kiddie tax will be different if a child has earned income or if the assets generate long-term capital gains and/or qualified dividends.
Although the new kiddie tax rules can lead to harsh consequences for many families, it may create tax-saving opportunities for higher-income taxpayers. Because the tax is now applied using the progressive rate structure for trusts and estates, rather than the parents’ marginal rate, parents can shift a limited amount of investment income to their children at lower tax rates. For example, parents in the 37% tax bracket can shift income up to $14,600 (the $2,100 unearned income threshold plus $12,500) before the 37% rate applies.
There are several ways to shift income to your kids without triggering kiddie tax issues. For example, you can:
- Transfer investments that emphasize capital appreciation over current income, allowing the child to defer income until the kiddie tax no longer applies;
- Transfer tax-deferred savings bonds;
- Transfer tax-exempt municipal bonds;
- Contribute to 529 college savings plans (see “How 529 plan benefits are expanding”); and
- Hire your kids.
Employing your children can be beneficial because earned income is not subject to kiddie tax and your business can also deduct the expense.
Look before leaping
Depending on your circumstances, shifting income to your children may reduce your tax bill. However, given the risk that income-shifting may increase it, look closely at the kiddie tax before you attempt this strategy.
Sidebar: How 529 plan benefits are expanding
A 529 college savings plan offers tax-free withdrawals of contributions and earnings used for qualified educational expenses. It is an effective way to fund a child’s educational expenses without raising kiddie tax concerns. Here are two reasons:
- Qualified distributions are tax-free.
- The plan typically is owned by the parents, not the student — which also provides a financial aid advantage.
Until recently, 529 plans could be used only for higher education expenses. Starting this year, you can use a 529 plan to pay elementary and secondary school expenses as well.
Navigating Your Way Through the Senior Housing Maze
If you, your parents or other elderly relatives are beginning to explore senior housing options, you probably know that there are many options to choose from. In fact, the number of choices can be downright daunting and leave you feeling emotionally exhausted. The best choice will depend on budget, the level of care needed and the facility’s distance to family and friends, as well as proximity to quality health care and desired cultural amenities.
Aging in place
According to Housing America’s Older Adults, a study by the Joint Center for Housing Studies of Harvard University, over 75% of those 80 years and above live in their own homes. 73% of Americans surveyed by AARP would prefer to remain in their own residence as long as possible.
The appeal of this option is understandable. Seniors remain in a familiar place and maintain independence — although they may be aided by family members, in-home nursing care or a housekeeping service. Remaining at home can also be less expensive than other options. The median rate for home health aide services is $135 per day, according to the Genworth 2017 Cost of Care Survey. Aging in place tends to work best for seniors who are relatively mobile, have family nearby and are actively involved in their communities.
For more-active seniors, age-restricted or adult retirement communities are another popular choice. Typically at least one person in each residence — which may be a house, apartment or condominium — has reached a certain age, such as 60 or older. The communities may offer exercise rooms, pools or other amenities. Most do not provide help with personal tasks or medical care, and costs usually rise as the number and quality of amenities increase.
Similar are independent living communities, which often go by names such as retirement communities or senior housing. The residences usually do not have staircases and otherwise vary by size. Typically, the community handles maintenance and may also provide meals and transportation services. However, independent living communities usually do not help with personal tasks or provide health care.
Older seniors and those needing assistance may want to consider an assisted living residence. Typically, residents live in their own apartments or condominiums, yet they can access help with such tasks as bathing or dressing, if necessary. Some assisted living facilities may stop short of providing full-time help or medical care. The median monthly cost is $3,750, according to Genworth.
Nursing homes or extended care facilities generally offer the highest level of assistance with daily tasks, as well as medical care. Often, a nurse or medical professional is available around the clock. Other medical services, such as physical therapy, also may be accessible. According to Genworth, the median monthly cost ranges from $7,148 for a semiprivate room to $8,121 for a private room.
All in one
Finally, continuing care retirement communities or campuses offer several options under one umbrella. These multiple-facility communities are becoming more and more common and can feature options ranging from independent living to assisted living to extended care.
Seniors can move from one facility to another if their physical condition changes, but remain within the complex. Costs vary depending on the facility and level of care needed, but usually include both an initial entrance fee and ongoing monthly fees. This option can be particularly attractive for family members of seniors who do not want to have to seek new housing every time their loved one’s condition changes.
Senior housing can be expensive. As you explore options, pay close attention to your budget. Your ORBA advisor can help you project costs over different time periods based on various options and help you determine how you will pay for them.
Choosing the most appropriate senior housing option for yourself or loved one will be an emotional roller coaster. Do your homework and lean on family, friends and advisors for their experiential knowledge – doing so will prove to be invaluable.