Saving on taxes, while saving for your child or grandchild’s college education, just got a little trickier thanks to important changes in the “Kiddie Tax”.
The tax bill that was signed into law in December made some significant changes to how Uniform Gifts to Minors Accounts (UGMAs) and Uniform Transfers to Minors Accounts (UTMAs) are taxed.
What is the “Kiddie Tax”?
“The “Kiddie Tax” was first established in 1986 to keep parents from shielding income by placing investment accounts in the names of their children, who typically are in lower income tax brackets,” explains CPA Joshua Harris of Santos, Postal & Company. “The initial Kiddie Tax rules expired when a child turned 14. In 2008, this threshold increased to cover children through age 18 and full time students through age 23.”
How were Uniform Gifts and Transfers Taxed?
UGMAs and UTMAs have been a popular way to save money in a child’s or grandchild’s name precisely because of their significant tax advantages. A portion of the money earned – the first $1,050 of the child’s investment income (including interest, dividends and capital gains distributions) has been tax-free; the next $1,050 has taxed at the child’s rate; and investment income above $2,100 was taxed at the parent’s or grandparent’s “marginal” tax rate, ie the highest rate applied to the last dollar earned.
How is it Changing?
The 2017 Tax Cuts and Jobs Act made an important change to this graduated “Kiddie Tax.”
Instead of a child’s investment income above $2,100 being taxed at the parent or grandparent’s individual tax rate, it will be taxed at the 2018 trust and estate tax rates:
| Investment Income | Trust & Estate Tax Rate |
| Up to $2,550 | 10% |
| $2,551-$9,150 | 24% |
| $9,151-$12,500 | 35% |
| Over $12,500 | 37% |
Will You Pay More or Less?
How much you will pay depends on the amount of investment income and your own marginal tax bracket. As a rule of thumb, the more you have the more you may be taxed this year.
While the Tax Code changed with this law, it unfortunately did not get simpler. And one alternative, if your rates are going up, may be to consider rolling the UTMA or UGMA into a 529 plan. Because of the complexity, it’s a good idea to speak with your Financial Planner about how the new law affects you, and what your best alternatives are now among the wide array of educational savings plans.
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