Figuring New ‘Kiddie Tax’ Is No Child’s Play
With Internal Revenue Service rules, nothing is simple, straightforward or sure.
The so-called kiddie tax reform in the 1986 tax law is a good example. Basically, it requires that children under 14 years old who earn more than $1,000 a year in investment income pay tax on it at their parents’ (surely) higher rate.
Some 600,000 children are expected to file under the measure, which is estimated to bring in an average of $200 million a year for the first five years. “In the context of the 1986 tax reform act, which was an enormous shift of tax liability,” says a staff spokesman for the House Ways and Means Committee, “this is a very small amount.”
But it was--or should have been--an easy change, if one assumes that legislators looking for revenue tax whatever draws the least political flak. They were after the rich, particularly those who have been shifting as much money and property as they could to their children--in savings accounts, stock, the so-called Clifford Trusts whose principal ultimately reverted to the parents--so the income on it would be taxed at the child’s lower rate.
Even if there were no abuse, it seemed a basic inequity that families whose entire income came from wages could shift none of their tax burden to their children, while families with income from investments could. According to the President’s 1985 tax proposals, the kiddie tax provision “would help ensure the integrity of the progressive tax rate structure, which is designed to impose tax burdens in accordance with each taxpayer’s ability to pay.”
Savings for College
The provision will also affect people, of course, who are not really rich income-shifters and may themselves have nothing but wages. One proposal was to set the income threshold at $2,000. It was also suggested that income on non-parental gifts be taxed at the child’s rate, but some feared that rich taxpayers would just start giving gifts to each other’s children or to grandparents who would then pass it on.
Middle-class wage-earners protest that their children have savings accounts not because they’re rich but because they need to save money for college. But IRS researchers point out that anybody who could amass $10,000 over the first 10 years of a child’s life would have to have put in $690 a year at an average 8% interest, or a lump sum of $4,632 at birth. It would be “difficult,” went the IRS line, for the median income household ($23,600 in 1985) to build such assets--and apparently no one above median has a legitimate squawk. Besides, they could save the money in their own name.
Principle aside, the kiddie tax got a sour reception, partly because of the IRS’ inherent inclination to complicate: The computation and filing required are no breeze. Even the IRS warned of complication last summer when it unveiled the special form (8615) that must be filed along with the 1040, 1040A or 1040NR, but noted that most people affected already have accountants or lawyers doing their taxes.
Standard Deduction
The basic 1040 returns must now be filed for any child under 14 with $500 in investment income (the yield perhaps of a $7,000 savings account) or $2,540 in earned income or both. If the child has more than $1,000 in investment income, he must also file the new 8615.
Like all dependents now, a child under 14 gets no personal exemption if he’s claimed as a dependent on the parents’ return. On earned income, he gets the standard deduction of $2,540, paying taxes on anything above that--presumably at 11%, the lowest rate. On unearned--or investment--income, he gets a deduction of $500, pays at a child’s low rate on any income from $501 to $1,000 and pays at the parent’s rate over $1,000.
If he has both kinds of income, it gets sticky, as everyone expected: Indeed, the cutoff age of 14 was specifically chosen because most children under 14 have no wages to complicate the filing. If they do, their standard deduction will now be the greater of $500 or the amount earned up to $2,540. Thus if a child earns $800 in wages and $400 in investment income, his deduction is $800; if he has $400 in wages and $800 in investment income, it’s $500.
Multiple Filings Worse
Unfortunately, the shortest 1040 this kid can use is the three-page 1040A, and there’s a lot of back-and-forth between that and the 8615. What’s more, the 8615 doesn’t just ask that one apply the parent’s tax rate to the child’s income. One computes the parent’s taxable income, adds the child’s, applies tax to the total and subtracts what the parents already paid on their own income: What’s left is the child’s tax. Thus, if the child’s income bumps the total into a higher bracket, the child might pay at a higher rate than the parents.
If there’s more than one child in the family, things get worse. One must add all the children’s investment income to the parents’, compute the tax for the family total, subtract what the parents paid on their own earnings and then--for each child--divide what’s left according to the amount of income he or she contributed to the kiddie pool. And if the parents later amend their tax return in any way, the children’s taxes must all be recomputed.
There are a few questions untouched. Can the child whose parents make too much (under the new law) to take exemptions for dependents have an exemption after all? How many ways will the really rich--the original target--avoid the tax entirely, simply shifting the child’s holdings into tax-exempt or tax-deferred investments?
And finally, why wasn’t the kiddie tax simple and decisive, requiring that all a child’s investment income over $1,000 be reported on the parents’ return, or maybe just ruling that any child with investments in his name--taxable, tax-exempt or tax-deferred--be sent to the slammer? That would do it.
