Historically, to prevent parents from shifting income to their children with lower tax rates, the “kiddie tax” applied the parents’ marginal tax rate to unearned income in excess of a de minimis amount ($2,100 in 2018 and $2,200 in 2019) for children under age 18 (24 if a full-time student).
The Tax Cuts and Jobs Act (TCJA) changed this computation for 2018 and subsequent tax years, simplifying preparation of kiddie tax returns, but subjecting the child’s unearned income to higher taxes. The rates for individuals and estates and trusts are the same, but they are reached at lower income thresholds for estates and trusts, so the kiddie tax rate on net unearned income was 10% for amounts up to around $2,500, 24% for income up to around $9,000, 35% for income up to around $12,500 and 37% for anything over that. This resulted in the minor being taxed at approximately $6,000 on $20,000 of net unearned income or approximately $30,000 on net unearned income of $90,000. These amounts were much higher than would have been paid previously because the rate brackets were much broader for individuals than for estates and trusts.
The Further Consolidated Appropriations Act, 2020 (FCAA) enacted at the end of 2019 retroactively repealed this provision of the TCJA and reinstated the “historic” computation subjecting the child’s unearned income in excess of the threshold to the parents’ marginal tax rate. This was done to prevent the unintended heavy tax on military death benefits paid to children of Gold Star families, on non-tuition scholarships paid to low-income students and on tribal distributions to Native American children.
Accordingly, the FCAA permits taxpayers to apply the parents’ marginal rate provisions retroactively to a child’s 2019 and 2018 unearned income under the pre-TCJA rules. This can be accomplished by filing a Form 8615, Tax for Certain Children Who Have Unearned Income, with an amended return or an initial return if the child’s 2019 return has not been filed. The savings would depend on the parents’ marginal tax rate, with no savings if the parents were at the highest income tax rate because the individual and trust tax rates would be the same.