Dependent Children's Income Taxation under TCJA 2018

The Tax Cuts & Jobs Act made several changes to the way dependent children's earned and unearned income are taxed for the years 2018-2025.

Definitions

A dependent child for tax purposes is a child of the taxpayer:

  1. Under the age of 18

  2. Under the age of 19 and does not provide more than half of his or her own support with earned income, or

  3. Under the age of 24, a full-time student, and does not provide more than half of his or her own support with earned income.

Earned income means wages, tips, and other income received as compensation for personal services. Unearned income is generally investment income such as interest, dividends, and capital gains. 

Nuts & Bolts

  • Self-employed parents should hire their children. Deduct child's wages against parents' business income. No need to pay SS or Medicare tax on earnings for a child under 18, and no federal unemployment tax on wages of a child under 21. (For this reason wages paid to children are closely scrutinized by the IRS, so they must be economically viable.)

  • The TCJA simplified the calculation of the kiddie tax.

  • Two tax-free limits, pre-"kiddie tax", to keep in mind are $2,100 of investment income and $2,600 of capital gains and qualified dividends. Combined, those create the possibility to shift up to $4,700 of income tax-free to each dependent child.

  • If the $2,600 investment income ceiling is too low, consider splitting the child's income or capital gains exposure with an irrevocable trust. That could enable an additional $2,600 of taxable income at a 10% ordinary income rate and potentially zero capital gains rate. (The rest of the trust tax bracket is ugly.)

  • The tax value to a parent of claiming an over-18 child as a dependent is significantly diminished by the TCJA. (The exemption deduction was repealed and child tax credit is only available until 17.)

In summary, don't discount the opportunity to use your offspring as financial planning chess pieces. 

Disclaimer: of course, always, without failure, consult a tax professional, none of this is formal tax advice.

 

 

Robinson Crawford