While the SECURE Act’s main intention is to create opportunities for individuals to save more for retirement, it also retroactively rolls back Kiddie Tax rates.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act went into effect January 1, 2020, and marked the end of the Kiddie Tax standard that was enacted just two years earlier. The Kiddie Tax, which can trace its origin back to 1986, was established to deter parents from shifting assets and income to their children in an attempt to reduce the parents’ tax bill. The Tax Cut and Jobs Act of 2017 signaled a major shift in how the Kiddie Tax was calculated.
Prior to 2017, children with unearned income would pay no tax on their first $1,100 of income and receive a favorable rate on their next $1,100 of earnings. Once they surpassed the $2,200 threshold, their income would be subject to taxation at their parent’s tax bracket.
This changed dramatically for those who were subject to the Kiddie Tax in 2018. Instead of being taxed at the parental tax bracket, the unearned income of children was taxed at trust and estate tax rates. Because the trusts and estates brackets have far lower thresholds than the ordinary income brackets have, the amount of income needed to hit the maximum tax rate is much lower. As a result, a child’s unearned income that exceeded $12,500 after the child’s standard deduction was taxed at a rate of 37%. This was a particularly large blow for average income earners who had minor children earning moderate amounts of unearned income.
Changes under the SECURE Act
The SECURE Act ends the taxation at trust and estate rates and reverts to the parental tax bracket standard that existed prior to the Tax Cuts and Jobs Act. This change was also retroactive for the 2018 tax year, which means that taxpayers may amend their 2018 tax returns to take advantage of the shift back to ordinary income tax levels.
Who should consider filing an amended return?
If your child had unearned income greater than $9,150 after the child’s standard deduction in 2018 — the threshold where the 35% federal tax rate began — you may be an ideal candidate to file an amended return. The tax rate increased to 37% when the child’s unearned income was greater than $12,500, after the child’s standard deduction.
If your child received this level of unearned income, the SECURE Act brings the biggest advantage for parents with moderate to lower ordinary income. For example, in 2018, a married couple filing jointly who made less than $315,000 after deductions would be subject to a Kiddie Tax of 24% under the SECURE Act — as opposed to as high as 37% prior to the new law. This tax rate difference could have significant impact on your tax liability.
Do you think you may be in this category? If your children had significant unearned income in 2018, speak with your tax professional to see if filing an amended return could lead to a refund.
How CLA can help
The SECURE Act has brought about many changes, and this retroactive repeal of the Kiddie Tax is just another example of how legislation can impact your tax situation and retirement strategy. At CLA, we take a holistic approach to financial planning to help you work toward the future you’ve imagined, and the future you deserve.