The TCJA changed the tax calculation for the kiddie tax which results in the child possibly having a higher marginal tax rate than the parents. This was highlighted by survivors of deceased members of the military in that a pension a child received was subject to more tax in 2018 than in prior years. A report on Military.com, “This Year’s Tax Cut Cost Some Gold Star Families Dearly,” 4/23/19, included an example of a child paying tax of about $1,150 on the benefits but owing $5,400 for 2018. This child’s parent is in a lower bracket than 37%.
While the TCJA does make the calculation one where the child can compute the tax without the need for the parent’s return, using the tax rate schedule for trusts where the 37% bracket is reached at just below $13,000 is wrong. Query – Why didn’t Congress say to use a rate structure 20 times the trust income tax bracket or some other percentage?
This issue caught the attention of some in Congress with proposals offered for relief for these benefits. S. 1370 and H.R. 2481 propose to treat the benefits as earned income so they are only taxed at the child’s tax rate. H.R. 2716 would not apply the TCJA changes to these benefits (so apparently still taxed at the parent’s marginal tax rate). H.R. 1994, a retirement bill passed by the House in May 2019 would change the kiddie tax calculation back to pre-TCJA times.
My proposal is to just repeal the kiddie tax. It is complex and isn’t taxing the owner of an investment at their own tax rate as intended by an income tax. If a family member gives a dividend-paying stock to a child, for example, it belongs to the child. The giver has forever parted with it.
Also, the kiddie tax is poorly targeted at trying to discourage parents from giving investment assets to their children because the tax calculation doesn’t ask about the source of the funds. For example, a child movie star with a big bank account is subject to the kiddie tax even though the source of the funds was her own efforts.
There is also something odd that happened with the kiddie tax back in 2013. When the kiddie tax was created by the TRA86, it was often described as taxing investment income of minors (it then applied to children under age 14). However, the language was broader to include unearned income using a definition under §911. It was also intended to address situations where family members transferred investment assets to children. So, a fix to treat the military benefits as earned income should help.
In 2013, IRS instructions for the Form 8615 and its title changed from Tax for Certain Children Who Have Investment Income of More than $1,900, to Tax for Certain Children Who Have Unearned Income. One notable change in the instructions was the IRS now calling taxable scholarships unearned income subject to the kiddie tax. Yet, Prop. Reg. 1.117-6 called that income earned. This was not an issue prior to the law change that increased the age of a “kiddie” from under age 14 to up to age 23 for certain full-time college students. [See Chambers, “Kiddie Tax May Be Due on College Scholarships,” The Tax Adviser, 4/1/16).] This treatment also seems odd in that there is no family transfer involved with the scholarship.
The Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222 (5/17/06) changed the age of a “kiddie” from under age 14 to under age 18, effective for tax years beginning after 2005. The Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28, 5/25/07) changed the age to its current levels. This also makes no sense to take the unearned income of a legal adult at the parent’s marginal rate.
The tax law would be simpler and more equitable and neutral to just repeal the kiddie tax.
What do you think?