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How Tax Reform Affects the Kiddie Tax

For years, many parents and grandparents have used Uniform Gifts to Minors Accounts (UGMAs) and Uniform Transfers to Minors Accounts (UTMAs) to save money in their child’s or grandchild’s name. These funds can then be used to help pay for future college education and other expenses.

Using UTMAs and UGMAs to gift money to minors in this way can reduce income taxes. This is because some, but not all, of the money is tax-free and some is taxed at the child’s lower rate.

What is the “Kiddie Tax”?

The tax reform that was signed into law in December makes some important changes to the taxation of earnings within UTMAs and UGMAs. These changes relate to what’s often referred to as the “kiddie tax.”

As noted above, when parents and grandparents give money to children, only a portion of the gift is tax-advantaged. In general, the first $1,050 of a child’s unearned investment income (interest, dividends and capital gains distributions) is tax free, while the next $1,050 is taxed at the child’s rate (probably 10%).

All unearned income above $2,100 was previously taxed at the parent’s or grandparent’s marginal rate. This taxation is known as the “kiddie tax,” though it’s not really a separate tax. Instead, it’s an income threshold above which a child’s unearned income is subject to higher taxes.

The IRS defines a child as being under 19 years of age or a full-time college student under 24 years of age. Previously, a child was defined as being under 14 years of age for kiddie tax purposes, but the age was increased by Congress to reduce opportunities for potential kiddie tax savings.

Impact of Tax Reform

The tax reform act made an important change to the kiddie tax. Starting with 2018 tax returns, instead of a child’s unearned income above $2,100 being taxed at the parent’s or grandparent’s marginal tax rate, it will be taxed at trust and estate tax rates. These rates in 2018 are as follows:

Unearned Income Trust & Estate Tax Rate
Up to $2,550 10%
$2,551-$9,150 24%
$9,151-$12,500 35%
Over $12,500 37%

So will this new rule result in a lower or higher kiddie tax? The answer depends on the amount of unearned income that’s subject to the kiddie tax and the parents’ or grandparents’ tax bracket.

Our Take

The details surrounding using UTMAs and UGMAs to give money to children and the potential tax implications can be complex and confusing. Be sure to speak with a tax and/or investment professional about your situation in more detail.

Read our free Personal Capital 2018 Tax Guide for Holistic Financial Planning to learn more about taxes and your long-term financial planning.

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This blog is for informational purposes only; we are not in the business of providing tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.

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