Minors

March 13, 2024

8603 / Who is taxed on the income from property that is transferred to a minor under a uniform “Gifts to Minors” act?

<div class="Section1">Editor’s Note: The 2017 tax reform legislation changed the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. Beginning in 2020, those rules were permanently repealed.<div class="Section1"> As a general rule, the income is taxable to the minor. However, as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8601">8601</a>, unearned income of children (even potentially up to age 23), may be subject to the kiddie tax. To the extent that income from the transferred property is used for the minor’s support, it may be taxed to the person who is legally obligated to support the minor.<a href="#_ftn1" name="_ftnref1">1</a> State laws differ as to a parent’s obligation to support. The income will be taxable to the parent only to the extent that it is actually used to discharge or satisfy the parent’s obligation under state law.<a href="#_ftn2" name="_ftnref2">2</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Rev. Rul. 56-484, 1956-2 CB 23; Rev. Rul. 59-357, 1959-2 CB 212. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 677(b). </div></div>

March 13, 2024

8601 / What is the “kiddie tax”?

<div class="Section1">Editor’s Note: Under the SECURE Act, the changes made by the 2017 tax reform legislation with respect to the kiddie tax rules were repealed. The repeal of the 2017 kiddie tax changes was effective beginning in 2020. However, taxpayers had the option of electing to apply either set of rules retroactively, in 2018 and 2019.<a href="#_ftn1" name="_ftnref1">1</a> The so-called “kiddie tax” is designed to prevent parents from shifting unearned income that would otherwise be taxed at their higher rates to their children to be taxed at lower rates. To prevent this type of income shifting, the kiddie tax subjected a child’s unearned income in excess of certain threshold levels (see below) to taxation at the parents’ highest marginal tax rate. The 2017 tax reform legislation aimed to simplify the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. Therefore, under the tax reform rule, earned income of minors was to be taxed according to the individual income tax rates prescribed for single filers,<a href="#_ftn2" name="_ftnref2">2</a> and unearned income of minors was to be taxed according to the applicable tax bracket that would apply if the income was that of a trust or estate (for both income that would be subject to ordinary income tax rates and income that would receive capital gains treatment).<a href="#_ftn3" name="_ftnref3">3</a> Under pre-reform law, which is once again applicable (see Editor’s Note, above), for the kiddie tax to apply, at least one parent must be alive at the close of the taxable year. The parent whose taxable income was taken into account is (a) in the case of parents who are not married, the custodial parent of the child (determined by using the support test for the dependency exemption, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8520">8520</a>) and (b) in the case of married individuals filing separately, the individual with the greater taxable income.<a href="#_ftn4" name="_ftnref4">4</a> If the custodial parent files a joint return with a spouse who was not a parent of the child, the total joint income is applicable in determining the child’s rate. If there was an adjustment to the parent’s tax, the child’s resulting liability also must be recomputed. In the event of an underpayment, interest, but not penalties, are assessed against the child.<a href="#_ftn5" name="_ftnref5">5</a> The kiddie tax applies only to “net unearned income.” “Net unearned income” is defined as adjusted gross income that is not attributable to earned income, and that exceeds (in 2025) (1) the $1,350 standard deduction for a dependent child plus (2) the greater of $1,350 or earned income plus $450.<a href="#_ftn6" name="_ftnref6">6</a> The source of the assets that produce unearned income need not be the child’s parents.<a href="#_ftn7" name="_ftnref7">7</a> “Earned income” means all compensation for personal services actually rendered.<a href="#_ftn8" name="_ftnref8">8</a> A child is therefore taxed at his own rate on reasonable compensation for services that he or she performs. Regulations specify that “unearned income” includes any Social Security or pension payments received by the child, income resulting from a gift under the Uniform Gifts to Minors Act, and interest on both earned and unearned income.<a href="#_ftn9" name="_ftnref9">9</a> The kiddie tax applies to: <blockquote>(1)  a child under age 18; or (2) a child age who has reached age 18, but whose earned income does not exceed one-half of his or her support; or (3) a child aged 19 to 23 who is a full-time student with earned income that does not exceed one-half of his or her support.<a href="#_ftn10" name="_ftnref10">10</a></blockquote> Whether a child’s age is below the threshold ages listed above is determined at the end of the tax year. “Child,” for purposes of the kiddie tax, includes children who are adopted, related by half-blood, or from a prior marriage of either spouse.<a href="#_ftn11" name="_ftnref11">11</a> The kiddie tax applies without regard to whether the child is considered a dependent for tax purposes. <blockquote>Example: In 2023, Pete is 16 and both of his parents are alive. During 2022, Pete has $1,400 of interest income from a bank savings account and $1,700 of income that he earned from a paper route. Some of the interest income is attributable to Pete’s paper route earnings that were deposited in the account. The balance of the interest was generated from cash gifts Pete received from his parents and grandparents. Pete has no itemized deductions and can be claimed as a dependent on his parent’s return. Therefore, for the taxable year 2023, Pete’s standard deduction is $2,100, the amount of Pete’s earned income, $1,700 from the paper route, plus $400. Of this standard deduction amount, $850 is allocated against unearned income, and $1,250 is allocated against earned income. Although some of Pete’s $1,400 of interest income is attributable to some of his paper route income deposited into his bank account, it is all treated as unearned income. Of that amount, $1,000 is taxed at Pete’s own tax rate (10 percent). The remaining taxable unearned income of $400 will be taxed at his parents’ highest marginal tax rate. Under the optional rules applicable from 2018-2019, the unearned income would have been taxed at 10 percent (the trust and estate tax rate), and the earned income would have been taxed as though Pete were any other single filer.</blockquote><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  SECURE Act § 501(c). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 1(j)(4)(B). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 1(j)(4). <a href="#_ftnref4" name="_ftn4">4</a>.  Temp. Treas. Reg. § 1.1(i)-1T, A-11, A-12. <a href="#_ftnref5" name="_ftn5">5</a>.  Temp. Treas. Reg. § 1.1(i)-1T, A-17, A-19. <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 1(g)(4). <a href="#_ftnref7" name="_ftn7">7</a>.  Temp. Treas. Reg. § 1.1(i)-1T, A-8, Rev. Proc. 2024-40. <a href="#_ftnref8" name="_ftn8">8</a>.  IRC §§ 911(d)(2), 1(g)(4)(A)(i). <a href="#_ftnref9" name="_ftn9">9</a>.  Temp. Treas. Reg. § 1.1(i)-1T, A-8, A-9, A-15. <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 1(g)(2). <a href="#_ftnref11" name="_ftn11">11</a>.  Temp. Treas. Reg. § 1.1(i)-1T, A-13, A-14. </div></div>

March 13, 2024

8602 / Can parents include the amount of their child’s unearned income subject to the kiddie tax on their own income tax return? How did tax reform change the treatment of unearned income of a child?

<div class="Section1"> Editor’s Note: Under the SECURE Act, the changes made by the 2017 tax reform legislation with respect to the kiddie tax rules were repealed. The repeal of the 2017 kiddie tax changes was effective beginning in 2020. However, taxpayers had the option of electing to apply either set of rules retroactively, in 2018 and 2019.<a href="#_ftn1" name="_ftnref1">1</a> The 2017 tax reform legislation aimed to simplify the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. Therefore, for tax years beginning in 2018 and 2019, taxpayers could opt to treat the earned income of minors according to the individual income tax rates prescribed for single filers,<a href="#_ftn2" name="_ftnref2">2</a> and unearned income of minors according to the applicable tax bracket that would apply if the income was that of a trust or estate (for both income that would be subject to ordinary income tax rates and income that would receive capital gains treatment).<a href="#_ftn3" name="_ftnref3">3</a> Under pre-2018 law and post-2019, under certain circumstances, parents can elect to include their child’s unearned income subject to the kiddie tax on their own income tax return, thus avoiding the necessity of the child filing a return. In 2025, the election is available to parents whose child has gross income of more than $1,350 and less than $13,500, all of which is from interest and dividends.<a href="#_ftn4" name="_ftnref4">4</a> However, by doing so, the parents increase their adjusted gross income and could become subject to potential phase outs or other reductions in tax benefits that decrease as AGI exceeds certain threshold levels. The election is unavailable if there was been backup withholding under the child’s Social Security number or if estimated tax payments have been made in the name and Social Security number of the child. <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. SECURE Act § 501(c). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1(j)(4)(B).h <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1(j)(4). <a href="#_ftnref4" name="_ftn4">4</a> IRC § 1(g)(7); Rev. Proc. 2008-66, 2008-45 IRB 107, as modified and superseded by Rev. Proc. 2009-21, 2009-1 CB 860. </div> </div>