Is unemployment income subject to kiddie tax?

In mid-March, right in the midst of an already delayed tax season, the American Rescue Plan Act (ARP) made the first $10,200 of unemployment income non-taxable per taxpayer. This change has tax preparers asking, is unemployment income subject to kiddie tax?

The tax on unearned income of children, known as the kiddie tax, applies when the child has unearned income of more than $2,200 (for 2020) and all the following apply:

• At the end of the tax year the child was:
  • Under age 18, or
  • Age 18 and didn’t have earned income that was more than one-half of the child’s support, or
  • A full-time student age 19-23 and didn’t have earned income that was more than one-half of the child’s support.
• At least one of the child’s parents was alive at the end of the year
• The child is required to file a tax return for the year
• The child doesn’t file a joint tax return for the year

To help understand the logistics, let’s look at an example:

Morgan and Jamie claimed their daughter Olivia on their 2020 tax return. In 2020, Olivia was 20 years old and a full-time student. She earned about $2,500 in the beginning of 2020 from a part-time job at a restaurant. Then the restaurant closed because of the pandemic and Olivia collected unemployment of about $13,000. She was not self-supporting; Morgan and Jamie continued to pay most of her expenses. They received the $500 other dependent credit and the American opportunity tax credit. Will Olivia be subject to kiddie tax in 2020? Would it make a difference if she was not claimed as a dependent? What about AMT?

In this instance, unemployment income is considered unearned income for kiddie tax purposes, therefore, Olivia will be subject to the kiddie tax because of her unemployment compensation.

• Unearned income is not limited to investment income such as dividends and interest. It includes any type of income that isn’t earned income, including unemployment compensation, taxable Social Security benefits, alimony, some taxable scholarships, and more.

Olivia will have to file her 2020 tax return as a dependent and complete Form 8615, Tax for Certain Children Who Have Unearned Income, to calculate the kiddie tax based on her parents’ tax rates.

The alternative minimum tax (AMT) exemption is $72,900 (for 2020) for single filers. Before the Setting Every Community Up for Retirement Enhancement Act (SECURE), a much lower AMT exemption applied to children subject to kiddie tax.

In 2017 the exemption was $7,500 plus earned income. Under the SECURE Act, starting in 2018, there is no special kiddie tax exemption, i.e., the same inflation adjusted AMT exemption applies to all filers. Because of the higher AMT exemption amount, Olivia will not pay AMT in 2020 and does not have to file Form 6251.

Kiddie tax vs. dependency status

Note that Olivia is subject to kiddie tax because she meets the criteria explained above and not because she is a dependent, whether or not her parents claim her.

Olivia is a dependent because she meets the qualifying child age, relationship, residency, and support test with respect to her parents Morgan and Jamie. The dependency rules and the kiddie tax rules are similar, but they are not identical.

For example, Olivia would not meet the qualifying child support test if she provided more than half of her own support from her total income and her other sources of support. In contrast, she would not meet the kiddie tax support threshold if she provided more than half of her own support based on her earned income only.

Non-dependents may be subject to kiddie tax. Suppose that in 2020 Olivia was not Morgan and Jamie’s dependent because she did pay more than half of her expenses from her total income of $15,500, and any other sources of support she may have, such as personal savings. In that case, she would file her 2020 tax return as a non-dependent.

However, assuming she did not pay more than half of her expenses from her $2,500 earned income alone, the kiddie tax would still apply. The same would hold true if she were not a dependent for some other reason, such as not living with her parents more than half the year.

(Originally published in the March 3, 2021 edition of TAX in the News.)

TCJA and the kiddie tax

Unemployment compensation is considered unearned income. A child who receives unemployment compensation may be subject to the kiddie tax, and as a result, may pay substantially higher tax than an adult receiving the same compensation. (This higher tax rate will apply to unearned income including investments and unemployment compensation, but normal income tax rates will apply to income earned from working.)

The Tax Cuts and Jobs Act (TCJA) made substantial changes to the kiddie tax in 2018 through 2025.

For 2018 and 2019, the kiddie tax was determined by the tax brackets and rates for trusts and estates.

• The first $2,600 (after the initial $2,200) is taxed at 10%
• The next $6,850 is taxed at 24%
• The next $3,500 is taxed at 35%
• Anything beyond that is taxed at 37%

However, the tax changes for 2020 now make the kiddie tax revert back to using the parental rates, instead of the rates for estates and trusts like in 2018 and 2019 above.

Remember that the kiddie tax only applies to unearned income in excess of $2,200.

Here’s another example of how a child with $15,000 of unearned income in 2020 would be taxed under the new law:

1. Regular tax rates apply to the first $2,200, which is exempt from the kiddie tax. The remaining $12,800 is subject to the kiddie tax.
2. The first $2,600 is taxed at 10%, leaving $10,200 to roll up to a higher rate.
3. $6,850 of the $10,200 is taxed at 24%, leaving $3,350.
4. The remaining $3,350 is taxed at 35%.

All taxpayer circumstances are different, and NATP recommends contacting our research department if you have specific questions about your clients’ tax situations. They can be reached at 800-558-3402, ext. 2, or submit your question online.