Big Change Afoot for the "Kiddie Tax" Under the New Tax Law

Note: The editors of Kiplinger's Personal Finance magazine and the Kiplinger Tax Letter are answering questions about the new tax law from subscribers to our free Kiplinger Today daily email. See other reader Q&As about the new tax law, or submit your own question.

Question: How does the new tax law treat the taxation of earnings inside a child’s Uniform Gift to Minors Account?

Answer: First, there is no change for 2017 earnings and, going forward, a child’s investment income in excess of a certain amount — $2,100 for both 2017 and 2018 — continues to be subject to the “kiddie tax.” But there is a big change.

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In the past, earnings subject to the kiddie tax were taxed at the parents’ tax rate. Starting with 2018 returns, the parents’ rate will not matter. Instead, investment earnings in excess of $2,100 will be taxed at the rates that apply to trusts and estates. Here are those rates for 2018:

• Up to $2,550 10%
• $2,550 to $9,150 24%
• $9,150 to $12,500 35%
• Over $12,500 37%

Note that under the new individual income tax brackets, the top 37% rate doesn’t kick in for individual taxpayers until taxable income exceeds $500,000. At first blush, it might appear that the severely compressed rate structure that tops out at $12,500 will trigger bigger tax bills than in the past. But that’s not necessarily the case. It depends on the amount of income subject to the kiddie tax and the parents’ tax bracket.

Consider, for example, a situation in which a UGMA throws off $5,000 of income subject to the kiddie tax and that the parents have taxable income of $150,000. In 2017, applying their 25% rate to the $5,000 would have cost $1,250. If the old rules still applied, using the parents’ new 22% rate would result in an $1,100 tax on that $5,000 of income. Applying the trust tax rates produces a kiddie tax bill of just $843 on the child’s investment income.

The kiddie tax applies to investment income of children under age 19 or, if full-time students, age 24.