25 Nov Year-End Tax Planning & the Kiddie Tax.
Year-End Tax Planning & the Kiddie Tax.
IRC §1(g)(2) – IRS Form 8615, one of the most common year-end tax planning considerations revolving around the implications of sheltering and feeding fully grown and educated children. Flying the coop has become increasingly difficult for the current generation of young adults “hanging” at Mom and Dad’s place as a young professional is the new ‘thing” to do. If you can…
The problem is that sheltering and feeding young adults has no income tax benefits, and if you give any of them more than $17,000 in 2023, you may be liable for Gift Tax—fodder for another post.
This post is for those of you with young adults and children who have unearned taxable income.
One particular taxpayer with an egregiously privileged reprobate child asked the following question:
“A custodial account was established for my daughter years ago. She turns 21 in January, and I can’t seem to get her out of my house. The account in question has a healthy long-term capital gain. Will she qualify for the zero capital gains tax rate if she sells the shares after the account was transferred into her name in 2017? She is currently in college and works part-time. I currently claim her as a dependent. If she sells the shares in the account before the year she turns 21, will the gains be taxed at my rate on my return?”
In response, the bottom line is – like most everything in the realm of taxation – it depends on intertwining characteristics of your specific situation as well as how the Internal Revenue Code and subsequent regulations read at the tax year of disposition, which undoubtedly will be different next year from what it is now.
The capital gain rate depends on one’s marginal tax bracket between 0% & 20% and does not distinguish between dependents and non-dependents.
Regarding reporting the daughter’s income, parents may notify their child’s income when it only consists of interest, dividends, and capital gains and is less than $10,500. In this case, the daughter has a part-time job, so she has earned income in addition to the interest, dividends, and capital gains.
This earned income will disallow the parent from reporting the daughter’s income on the parent’s tax return. Based on the fact pattern as presently known, it appears the daughter will be obligated to file her tax return asserting via check box that she is a dependent of the parent.
Additionally, depending on the amount of unearned income the daughter has, she may be subject to kiddie tax rules and may have to pay taxes at the parent’s marginal tax rate.
Once it is determined a dependent must file a tax return, the next step is to determine if the dependent child is subject to kiddie tax rules.
Kiddie tax is a tax burden because it could subject the daughter, in this case, to the mother’s tax rate.
Under IRC §1(g)(2), kiddie tax rules apply when a child has an unearned income of more than $2,300. This rule, interestingly enough, applies even if the child is not a dependent. The central point of kiddie tax is counteracting income shifting from higher income earning parents to lower income making children. Effectively, the kiddie tax imposes the parents’ marginal tax rate (if higher) on the child’s income and taxes the family as a whole unit instead of separate parts.
Kiddie tax occurs most often in the following instances:
- High-income parents invest their money under their children’s name, hoping to have the earnings taxed at the child’s lower tax rate instead of the parent’s higher tax rate.
- Children receive large inheritances or settlements, resulting in high unearned income.
For purposes of kiddie tax, unearned income is NOT wages, salaries, and self-employment earnings.
Unearned income includes, but is not limited to, the following types of payment:
- Ordinary dividends
- Capital gains, including capital gain distributions
- Partnership K-1s with passive income
- Taxable social security benefits
- Pensions and annuity income
- Taxable scholarship and fellowship grants not reported on Form W-2
- Unemployment compensation
- Income received as a trust beneficiary
- Prizes, awards, and gambling
In the case of the daughter, she must file IRS Form 8615, Tax for Certain Children Who Have Unearned Income, if:
- She had more than $2,100 of unearned income – including capital gains – and became a full-time student at the end of 2017
- She did not have EARNED income that was more than ½ of her annual support in 2017. Earned income includes wages, tips, and other payments for personal services. This is a moving target as ‘support’ varies based on lifestyle choices.
- She did NOT file a joint return in 2017
- The mother or the father is alive at the end of 2017
In this case, if a sale occurs before transferring to the daughter or if the daughter is subject to taxation at the parent’s rate due to kiddie tax rules, the daughter will pay at the parent’s marginal tax rate.
IMHO, I would resist the urge, in this case, to create capital gains until the daughter is no longer a claimed dependent as (in theory) she will have a marginal income tax bracket commensurate with a young adult in her first career and (in view) have a substantially lower effective income tax rate than the parent, an established professional.
Of course, the most conservative action is to file IRS Form 8814, report your child’s interest and dividend information on your tax return, and pay income tax on those earnings at your marginal tax rate.
Frustrating but important considerations for parents
- If a child has earned income, Form 8814, Parents’ Election to Report Child’s Interest and Dividends, cannot be used, and Form 8615 must be filed instead.
- Taxpayers should know that the parent’s taxable income is reported on Form 8615.
- Although parents may not be pleased that their income must be disclosed on Form 8615, such disclosure does not violate the confidentiality requirements applicable to preparers.
- Reg. §301.7216-2(e)(1)(i) provides an exception to disclosure and use of the parents’ information without their formal consent when the “second taxpayer is related to the first taxpayer.”
Contact me for more information on Year-End Tax Planning & the Kiddie Tax – IRC §1(g)(2) – IRS Form 8615.