Lately, much attention has been paid to how the so-called kiddie taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. changed under the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. , and the effect of that change on children. At first, the change to the kiddie tax seems minor; but it can cause a significant increase in a child’s tax liability, especially for children from low-income families. This issue has grabbed the attention of Congress, leading to several proposals providing a variety of fixes, ranging from a total rollback of the new changes to a fix exclusively for Gold Star families (families of deceased servicemen and women).
The kiddie tax is a tax on a child’s unearned income, such as interest, dividends, and capital gains, not wages. Policymakers designed the kiddie tax to prevent parents from passing their unearned income to their children to avoid paying higher tax rates. Before the TCJA, the kiddie tax taxed unearned income at the parents’ marginal income tax rate, with additional considerations given to the tax situations of parents and unearned income of other siblings. The TCJA simplified the kiddie tax calculation by taxing the child’s unearned income using the estate and trust tax rate schedules and removing the requirement to consider other family members’ tax situations. This simplification, however, has important consequences due to the transition to a new rate schedule.
Marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s for individual income earners and the estate and trust rate have very different tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s, with estates and trusts hitting top marginal rates much faster. If the kiddie tax were still calculated using traditional marginal tax rates, unearned income would be taxed at the top rate of 37 percent if a parent earns more than $510,300 as a single filer, or $612,350 if married filing jointly. However, under the estate and trust tax schedules, unearned income exceeding $12,751 is subject to the 37 percent tax rate. For children in low-income families, their unearned income is now being taxed at a much higher rate.
Recently, several news stories surfaced highlighting tax increases for certain groups of children, particularly Gold Star families, that have grabbed the attention of Congress. The Senate has acted first on a fix for Gold Star families. The House of Representatives is considering a bill that would revert the calculation of the kiddie tax to the method used before the TCJA. The House legislation is, therefore, much broader than just Gold Star families. These differences in legislation between the House and Senate will need to be resolved before a bill is sent to the president.
It is important to note that the TCJA reduced the overall tax liability for 80 percent of Americans. However, the kiddie tax change raised a portion of taxes for some taxpayers. There are several different legislative proposals to alter the treatment of a child’s unearned income, each with its own affects for policymakers to consider.
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