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Parents and grandparents often transfer IRAs to minor children within their estate plans. A rule called Tax on a Child’s Investment or Other Unearned Income (also known as the “kiddie tax”), was enacted to curtail transfers for the main purpose of avoiding higher taxes that would be paid by adults. The recently enacted Tax Cuts & Jobs Act (TCJA) makes subtle changes to this rule.
An IRA can be a great legacy to leave minor children. The child receives required minimum distributions, but because of her age, most of the money stays in the account and keeps earning. Before the enactment of the TCJA, the standard deduction for a child declared as a dependent on a parent’s tax return was $1050 and the kiddie tax only kicked in once unearned income reached $1050. This means, only investment earnings above $2100 were taxed, and the rate matched the parents’ tax rate. Under the TCJA, this threshold for the kiddie tax remains the same, however, the income will now be taxed using the schedule for Estates and Trusts, which reaches higher rates more quickly than the rates used on personal income.
The new structure has the greatest impact on those with higher investment income. For example, while the first $2,550 above the threshold is taxed at 10 percent, the next $6,600 will be taxed at 24 percent. At the top level of any dollar amount above $12,501, the rate reaches 37 percent.
One way to minimize tax liability when leaving an IRA to minor children, kids, is to use a Roth IRA as opposed to a traditional IRA. As long as the account holder had the Roth account for more than 5 years, there is no tax on required minimum distributions.
Using an IRA as an estate planning tool can be a great way to transfer wealth to minors. However, there are strategies available to limit tax liabilities and these should be discussed with an experienced trusts and estates attorney.