Kiddie Tax Changes

In December 2017, Congress enacted the Tax Cuts and Jobs Act (TCJA) and changed how your children calculate their tax on their investment-type income. The TCJA changes led to much higher tax bills for many children.

On December 19, 2019, Congress passed a bill that the president signed into law on December 20, 2019 (Pub. L. 116-94). The new law repeals the kiddie tax changes from the TCJA and takes you back to the old kiddie tax rules, even retroactively if you so desire.

Kiddie Tax Basics

When your children are subject to the kiddie tax, it forces them to pay taxes at a higher rate than the rate they would usually pay.

Here’s the key: the kiddie tax does not apply to all of a child’s income, only to his or her “unearned” income, which means income from

  • dividends,
  • rent,
  • capital gains,
  • interest,
  • S corporation distributions, and
  • any type of income other than compensation for work.

For 2019, your child pays the kiddie tax only on unearned income above $2,100. For example, if your child has $3,000 of unearned income, only $900 is subject to the extra taxes.

Who Pays the Kiddie Tax?

The kiddie tax applies to children with more than $2,100 of unearned income when the children

  • have to file a tax return,
  • do not file a joint tax return,
  • have at least one living parent at the end of the year,
  • are under age 18 at the end of the year,
  • are age 18 at the end of the year and did not have earned income that was more than half of their support, or
  • are full-time students over age 18 and under age 24 at the end of the year who did not have earned income that was more than half of their support.

Calculating the Kiddie Tax

Under the TCJA, now valid only for tax years 2018 and 2019, any income subject to the kiddie tax is taxed at estate and trust tax rates, which reach a monstrous 37 percent with only $12,070 of income in tax year 2019.

Under the old rules before the TCJA, your child paid tax at your tax rate on income subject to the kiddie tax.

Kiddie Tax Choices

The SECURE Act, which the president signed into law on December 20, 2019, repeals the TCJA kiddie tax rules for tax years 2020 and forward and returns the tax calculation to the pre-TCJA calculation that uses your tax rate.

The new law also gives you the option to calculate the kiddie tax using your tax rate for tax years 2018, 2019, or both—it is your choice.

Does No 1099 Mean No Deduction for You?

Imagine this: you didn’t issue Form 1099s to your contractors. Now, the IRS is auditing your tax return, and the auditor claims you lose your deductions because you didn’t issue the Form 1099s. Is this correct?

No. IRS auditors often make this claim, but they are incorrect.

There is no provision in the federal tax law that denies you a deduction for labor expenses simply because you didn’t file the required Form 1099s. But the tax court has stated that the non-filing of required Form 1099s can cast doubt on the legitimacy of the deduction claimed.

As with any deduction claimed on the tax return, you have to keep sufficient records to substantiate the deduction amount. If you had filed Form 1099s, then this would have been solid documentation to help prove the expenses to the auditor.

But since you didn’t file Form 1099s, you need to provide ironclad documentation to prove the expenses, including some or all of the following:

  • Bank statement transactions
  • Canceled checks
  • Credit card statement transactions
  • Invoices from the contractor
  • Signed agreements with the contractor
  • A signed statement from the contractor verifying the amounts received

Ultimately, to prove your deduction in a court of law, should you have to go that far, you’ll need to show by a preponderance of the evidence that you made the payments. This means that your evidence has to make it more than 50 percent likely that you did make the payments to the contractors.

Besides the extra trouble of proving the deductions, keep in mind that the cost of not filing Form 1099s surfaces a financial penalty. For the 2019 Form 1099s, the potential penalties are

  • $270 per Form 1099, or
  • $550 per Form 1099 if the IRS determines you intentionally disregarded the requirement.

As you can see, filing the 1099s avoids trouble.