By Jennifer Murphy, Senior Tax Associate
With the new tax law in effect for 2018, parents and guardians will want to pay close attention to modifications made to the Child Tax Credit and Kiddie Tax rules and how these changes may affect them.
Child and Dependent Tax Credits
Under the 2017 Tax Cuts and Job Act (“the Act”), the Child Tax Credit will increase from $1,000 for each qualifying child under age 17 to $2,000. Under the pre-Act law, this credit had a phase-out of $50 for each $1,000 of Adjusted Gross Income (“AGI”) over $75,000 for Single filers, $110,000 for Married Filing Joint taxpayers, and $55,000 for Married Filing Separate taxpayers. With the new Act, the income levels at which the credit phases out have increased significantly to $400,000 for Married taxpayers filing jointly and $200,000 (not indexed) for all other taxpayers.
Altogether new for 2018 will be the addition of a $500 nonrefundable credit for certain qualifying dependents other than qualifying children. It is important to note that no credit will be allowed to a taxpayer for a qualifying child unless the taxpayer provides the child’s Social Security Number.
The Child Tax Credit is one of few federal tax credits that actually becomes refundable in cases where the taxpayer’s liability ends up being less than the Child Tax Credit for a qualifying child. Under the old rules, this amount (which was considered an Additional Child Tax Credit) was limited to $1,000 per qualifying child. The new Act has raised this limit to $1,400 (indexed for inflation).
Parents of children with unearned income will also want to review the new Kiddie Tax rules that have changed how a child’s income is taxed. Under pre-Act law, the net unearned income of a child was taxed at the parents’ tax rates if the parents’ tax rate was higher than the child’s tax rate. The child’s tax rates were used for the remainder of taxable income (earned income, plus unearned income – up to $2,100 for 2018, less the child’s standard deduction).
In an effort to simplify the Kiddie Tax rules, the child’s earned income will now be taxed at the single individual rate, and the net unearned income will be taxed at the (often higher) ordinary and capital gain rates that apply to trusts and estates. Therefore, with simplification comes the potential for a higher tax rate than in the past. It should be noted that a child will reach the highest tax bracket for unearned income (37% on interest, non-qualified dividend and short term capital gains and 20% on qualified dividends and long term capital gains) at $12,501. Additionally, the 3.8% Net Investment Income Tax will apply when a child’s AGI is greater than $12,501. So additional tax planning in these cases is well-advised.
It is important to know that Kiddie Tax potentially applies to the unearned income of dependents under age 18 or full time students under the age of 24 if the child’s earned income did not exceed one half of the child’s own support for the year (excluding scholarships).
Keep in mind that this new tax regime applies only through December 31, 2025 and then returns to the pre-Act (measuring Kiddie Tax based on the parent’s tax bracket).
While the new tax Act provides opportunity for increased tax credits, it may also raise the tax cost on unearned (investment income) of children.
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- Charitable Contributions: Changes With the New Tax Law
- Tax Cuts and Jobs Act: What you need to know about the Estate, Gift & Trust Provisions
- AMT Changes to Individuals and Businesses
- Excise Tax Changes Impact Tax Exempt Organizations
- Understanding the New Section 199A Pass-through Deduction
- Tax Cuts and Jobs Act Resource Guide