4 ways to cut down kiddie tax

Now the “kiddie tax” is all grown up.

Alert: The new Tax Cuts and Jobs Act (TCJA) changes the way that the kiddie tax is calculated, beginning in 2018. The revised rules will frequently produce a bigger tax than the amount that would have been owed under prior law.

Nevertheless, you can cut kiddie tax down to size with some astute tax planning.

Here’s the whole story: Under prior law, the kiddie tax applied to “unearned income” (i.e., investment income) above a specified annual threshold that was received by a dependent child under age 19, or a full-time student under age 24. Any excess unearned income above the threshold was taxed at the top tax rate of the child’s parents, regardless of the source of the income.

The kiddie tax threshold for 2017 was $2,100, while the top ordinary income tax rate for parents was set at 39.6%.

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The TCJA changes the methodology used to figure out the kiddie tax. The tax calculation is now based on the federal income tax rates and brackets for estates and trusts. Key point: The tax brackets for estates and trusts are more compressed, so the higher rates kick in sooner. We’ll spare you all the gory details, but the new calculation generally results in a kiddie tax bill that is higher than would have been the case under the old rules.

The kiddie tax unearned income threshold for 2018 remains at $2,100, while the top rate for estates and trusts is 37% for 2018–2025.

But there’s no need to panic. By using one or more of these four strategies, you may be able to reduce the kiddie tax hit for 2018 or avoid it completely.

1. Stay below the annual threshold. The kiddie tax only applies to a child’s unearned income above the $2,100 threshold. For instance, you might wait until next year, or even the year after, to give your child income-producing property. This technique works especially well if the child won’t be in the kiddie tax danger zone any longer at that point.

2. Minimize currently taxable unearned income. When appropriate, you should have your child make investments that will not produce current income. For example, this may include growth stocks and U.S. Savings Bonds. Similarly, if the child buys certificates of deposit (DCs) or Treasuries that will not mature until 2019, it can reduce kiddie tax headaches for 2018.

3. Go tax-free. Allocate a portion of your child’s investment portfolio to municipal bonds (“munis”) or muni bond funds. The income received from these investments is completely free of federal income tax. Therefore, your child can collect the payouts without any kiddie tax kiddie concerns.

4. Hire your child to work for your company. Remember that the kiddie tax is limited to “unearned income.” Conversely, wages constitute “earned income,” so the salary paid to your child won’t trigger kiddie tax complications. Icing on the cake: As long as the child is paid a reasonable salary for the services performed, your company can deduct the wages. This also helps a child save money without adverse tax consequences.

Tip: Check your child’s kiddie tax status midway through the year and make any necessary adjustments.