The Further Consolidated Appropriations Act, 2020 (P.L. 116-94), which was signed into law on Dec. 20, 2019, made a number of dramatic changes that impact the taxation of children. If you are the parent of a minor child, it's up to you to file an income tax return on their behalf if one is required. Here are some changes of note.

Kiddie Tax

Like adults, children must file a tax return if they have sufficient income to warrant it (filing thresholds change annually and special threshold apply to children who are dependents). For certain children, there's a "kiddie tax." This is not a separate tax, but a method of figuring tax on a child's unearned income over a threshold amount ($2,200 in 2019 and 2020) (Code §1(g)). The nature of the income as being unearned income (e.g., bank interest, dividends, capital gain distributions, and taxable scholarships) controls the applicability of the kiddie tax and not the source of the income (e.g., a gift from a parent or other relative or investment return on a child's earned income). The purpose of the kiddie tax, which was introduced by the Tax Reform Act of 1986, is to prevent parents from shifting investment income to children as a way to reduce the overall tax bill for the family.

The kiddie tax applies to a child with a living parent and who is under age 18 at the end of the year, age 18 but less than 19 and earned income that does not exceed half of his or her support, or age 19 but under 24 and a full-time student. It does not include a child who files a joint return with another taxpayer. The Tax Cuts and Jobs Act of 2017 (TCJA) changed the way in which the kiddie tax was calculated. Prior to this law, the tax on the child's unearned income over the threshold amount was figured using the parent's marginal rates for ordinary income as well as for long-term gains and qualified dividends. This required waiting for the parent to file his/her (or joint) return to know what that rates were. The TCJA substituted the rates for trusts and estates. However, this change meant, for example, that children receiving survivor benefits from a parent killed in combat were severely penalized in the amount of taxes paid. As a result, the spending measure repealed the TCJA change effective for 2020. The spending measure allows the former rules to be used for 2018 and/or 2019 returns at the taxpayer's election. Thus, the parent's rate can be used to figure the kiddie tax on a 2019 return. If desired, an amended return can be filed for 2018 on which an election is made to use the parent's rates and obtain a tax refund. And parents continue to have the option of reporting the child's unearned income on their returns, if eligible, using Form 8814, Parents' Election to Report Child's Interest and Dividends.

A child may also be subject to the alternative minimum tax (AMT). There had been a special AMT exemption amount for individuals under age 24. Again, the spending measure suspended for 2019 and 2020, and retroactively for 2018, the special exemption amount. As a result, a child subject to the AMT can use the exemption amount for his/her filing status. And again, if a child paid the AMT in 2018 but would not have owed it if the regular AMT exemption (and not the special one) was used, consider filing an amended return.

Stretch IRAs

Parents and grandparents may want to leave their retirement accounts and IRAs to children or grandchildren. They can designate such individuals to inherit the accounts on their demise. Until now, non-spouse beneficiaries, including children and grandchildren, who inherited these accounts could stretch their required minimum distributions (RMDs) over their life expectancy (determined by Table I, Single Life Expectancy, in the Appendix of Publication 590-B). The spending measure (which includes the SECURE Act) eliminates the so-called stretch IRA by requiring accounts to be fully distributed by the end of the 10th year following the year of death. There are no RMDs during this period, although distributions can be taken at any time. However, special rules apply to "eligible designated beneficiaries." An eligible designated beneficiary includes a minor child.

A minor child for this purpose is a person who has not reached the age of majority under state law (usually age 18). However, a child who is has not completed "a specified course of education" may be considered a minor until age 26 (Reg. §1.401(a)(9)-6), although the meaning of this is not entirely clear. A grandchild is not an eligible designated beneficiary under this rule, although the grandchild could be one under another designated beneficiary category, such as a disabled individual.

The rules for RMDs for a minor child are complicated. While they are minors, they continue to take RMDs under the old rules. However, once they reach the age of majority, whatever that is, then the 10-year period begins to run.

For minor children who inherited accounts from a person who died before 2020, the old rules continue to apply; they are grandfathered in for the current beneficiary. For example, an owner died in 2019 and named her grandchild as the designated beneficiary of her IRA. The grandchild's life expectancy was set to run for 66 years. The grandchild can continue to take RMDs over this period. However, when the grandchild dies, whatever is remaining in the account and payable to a successor beneficiary must be distributed according to the new anti-stretch rules.

Distributions From 529 plans

The spending measure introduced two new opportunities for using funds from 529 plans on a tax-free basis to benefit children. Both rules apply to distributions made after Dec. 31, 2019 (i.e., they do not have to be reported as taxable distributions on 2019 returns).

• Apprenticeship programs. Qualified expenses for purposes of 529 plans include costs associated with registered apprenticeship programs (those certified by the Department of Labor under Section 1 of the National Apprenticeship Act). Costs include fees, books, supplies and required equipment (e.g., tools for a trade).
• Student loan repayment. Qualified expenses also include the payment of student loan debt up to $10,000 in a lifetime. However, funds can also be used to pay student loan debt of a beneficiary's siblings (brothers, sisters, stepbrothers, and stepsisters) up to $10,000 each. The portion of student loan interest paid with a 529 distribution is not interest for which a student loan interest deduction (Code §221) can be taken; no double dipping is allowed.

Conclusion

The new rules should be taken into account in preparing 2019 income tax returns for children. They should also be used for planning for the future.

Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink and senior consultant to Citrin Cooperman & Company.