Can the IRS Lift the Spirits of Pandemic Parents? How about a “Kiddie Tax” Refund?

The so-called “Kiddie Tax” is a tax imposed on a child’s unearned income. Generally, a “child” means someone under 17 years old (or under 24 if certain criteria are met) and “unearned income” means income derived from sources not related to employment, including investments.

For many years, the Kiddie Tax was the greater of two calculations: the tax on the child's income as if the Kiddie Tax did not exist, and a far more complicated calculation using the parent’s marginal tax rates.

In 2018, Congress passed the Tax Cuts and Jobs Act (TCJA), which (among other things) attempted to simplify the Kiddie Tax. The TCJA taxed a child’s net unearned income at the same rates that applied to trusts and estates. This calculation was simpler, but the simplification came with a cost, since the tax rates for trusts and estates are quite unfavorable when compared to the tax rates for individuals. For example, for 2020, the trust tax bracket applies the rate (37%) once taxable income exceeds $12,950; for married filing jointly, that level is not hit until $622,050.

In 2020, Congress un-did their simplification, reverting to the pre-TCJA rules, as part of the SECURE Act. This means that, for 2020, a child’s income can be based on the parent’s marginal tax rates, rather than be subject to the higher tax rates for trusts and estates.

Most importantly, Congress made this fix retroactive to tax year 2018. As a result, anyone that paid “Kiddie Tax” at the trust tax rate may be able to obtain significant tax savings for the prior tax years.

We are examining the issue for clients who have their trusts with us here at Washington Trust Wealth Management. However, anyone subject to the Kiddie Tax should consult with their tax advisor to see if they may be able take advantage of this potential refund opportunity.