Kiddie Taxes

[kork13]

Hot on the heels of the discussion on people maneuvering around the tax code for their own personal gain....

Is anyone familiar with Kiddie Taxes?

When I was looking yesterday at our quarterly growth, I noticed that our sons' UTMAs each currently have $2k - $3k in LTCG. They're only 3 & 5 y/o, so they have no earned income, though they do receive the Alaska PFD (~$1k/person last year...but I know it's also treated differently). I was thinking that it might be smrt [sic] to slowly start to realize some of their gains, while keeping those LTCG below the limit for actually owing any taxes on it (tax gain harvesting). But I'm not terribly familiar with how taxes for minors work, so I've got a number of questions, if anyone can help clarify:
1) I'm assuming this strategy is legal & ethical....?
2) I'm unclear on what the tax-free limit is for a dependent minor. From some looking on the IRS website (and a few links from that page), I'm pretty sure that anything under $1100 is not taxed, and doesn't require filing a return on behalf of my child. But I'm also seeing references to a limit of $2200, and I'm not understanding what that limit is about.
3) For 2020, they received $80-$110 in mostly-qualified dividends, and my understanding is that I would need to reduce any LTCG sales by roughly that amount to stay under whichever limit (per #2) is applicable? ...Basically, confirm dividends & LTCG are treated the same for them?
4) At what point would I actually need to file a tax return on their behalf?
5) If/when their LTCG/dividends do exceed the limit & become taxable, what is their tax rate? I know at some point, their income will become taxed at my rate....
6) For the act of running the tax gain harvesting... Because it's all gains, Vanguard will allow me to sell one day then re-purchase the same MF the very next day, correct?

The IRS pubs are bewilderingly complex... anyone have a better read on how all of this works? There's probably other things to consider that I haven't caught/questioned yet, so I may just need to go ask a pro... But any clarity you all can offer is appreciated!

[Like2Plan]

The answer to #1. is yes it is legal and ethical. It might even be argued that you have a fiduciary responsibility to manage to their best interest/optimum tax efficiency..

questions 2-6. I don't know. The TCJA really put the whammy on kiddie taxes, but then I "think" it was the SECURE act corrected some of the more drastic changes (like kids getting taxed at the trust rate above a certain threshold which in many cases was a higher tax rate than the marginal tax rate of the parents ). I don't know if that has all settled out where you could google the topic (or if the next three tax laws changed it again).

https://www.irs.gov/taxtopics/tc553

https://www.forbes.com/sites/leonlabrecque/2020/01/09/bonus-round-in-the-secure-act-the-kiddie-tax-glitch-is-fixed-and-it-can-save-families-thousands-in-taxes/?sh=2e3a6194106d

https://proconnect.intuit.com/taxprocenter/tax-law-and-news/kiddie-tax-resets-for-2020/

[Jluke]

Tax gain harvesting.

I would visit the vanguard fans forum and wiki to get more details.

I should be doing this too for my kids

[MonkeyMama]

The kiddie tax rules have changed twice in the last few years. I haven't paid close attention to the details. I have tax harvested my kids' income for years and they have never paid any significant tax on gains. But CA does not have favorable capital gains rates, so I personally try to keep it at around $1,000 annually ($1,000-ish is tax-free for us, both Fed/State). I mention because A - I have never gotten into the weeds of the kiddie tax. But also, B - you will have to figure out your state too (if you have a state income tax).

But I am looking at and referring the latest update, to answer your questions:

#2 - Keep 'unearned income' under $2,200 to avoid paying at parent tax rates.

#3 - Yes, any investment income (dividends and capital gains) are subject to that $2200 limit.

#4 - Use the IRS tool to see if you are required to file. I personally go through this every year. It's just way too freaking complicated, so I make triply sure (if I don't think there is a filing requirement). See link below.

You are required to file if you do have stock or mutual fund sales (if you received Form 1099-B). It is extra paperwork (more tax filing) to harvest all those gains. It's technically not "required", but you will get IRS notices if you do not. The IRS will tell you all of this (re: 1099-B Forms) if you go through the link.

#5 - These are the details I personally have never paid any attention to and I do not know off the top of my head. Sorry!

#6 - Maybe.

It depends what kind of securities you are buying/selling. Most?** Vanguard mutual funds, you can't just buy and sell the same day. There are workarounds, but they have 'frequent trading' policies. For me personally, I never really bought and sold the same security. Just something similar. I believe one workaround if you want to buy the same security, is you can set up an 'automatic periodic investment' and then turn it off after the first buy. I have done this before. But over time, all the big brokerages keep offering more and more mutual funds, and I just don't bother with this any more. I just trade for something similar. Frequent trading policies aside, there's nothing to stop you from selling and buying the same security in a short time frame.

**I guess I don't know if it's most Vanguard funds, or just all the ones I want to buy.

Bogleheads is a really good resource for these type questions.

[MonkeyMama]

P.S. My post got too long and I forgot to add this.

They retroactively changed the kiddie tax laws to remove the higher trust tax rates. So if you did pay higher trust rates in 2018 or 2019, you can amend those tax returns and get a refund. Just a general FYI for everyone.

[MonkeyMama]

Clarification on #2 & #5 came to me in my sleep. Just kind of woke up with some clarity.

If you are a dependent, your standard deduction is the greater of $1,100 or 'your earned income plus $350'. But no more than $12,400 (single filing status).

So pretty much the first $1,100 is tax free (offset by dependent standard deduction). <---This is mostly my strategy and I personally haven't gotten into the weeds with more income.

Between $1100 and $2200, kids pay tax at their tax rate. Which is probably a 10% tax rate on ordinary income (nonqualified dividends) and 0% LTCG rate. This is probably why it gets confusing, because you get to use that 0% LTCG rate for that first $2,200 of unearned income.

You can look at IRS Form 8615 if you want to get more into the weeds.

[kork13]

MonkeyMama thank you! That all is hugely helpful!

[LivingAlmostLarge]

If you buy and sell stuff you really need to file them. I have been adding the $10 bank interest or $50 of bank interest to my returns for years because i'm lazy. But this year I sold off some positions and took losses that I need to carry forward and now I write off against the kids gains. So I can't just add on to my tax return their small bank interest (which seriously) is more worth it to save the headache. So if you don't care and just buy and hold or too lazy it's way easier to add them to your tax return. It really sucks though when you have to do their own.

[kork13]

Okay, new Kiddie Taxes question, centered on optimizing it ... because I know it's a factor this year.

Between their UTMAs & Alaska PFDs (2-3x higher than previous years), my kids are over the reporting threshold & must report their 'unearned income'. What I'm trying to figure out & striking out on is if I should (better/less tax-costly for us) report their income on MY return (via Form 8814, which they do meet the requirements for), or if it's better to file for them individually. They're in the grey area (>$1150 but <$11,500 .... ranges from $3300-$3500 for each of our 3 kids) of not being required to to file individually, so it's basically an option to me. I just don't know how to figure out which one is better for us... No idea how to approach the issue. Does anyone have experience/expertise with kiddie taxes? If it matters, our AGI is $150k (including DKs' ~$10k income), so we're solidly in the 22% bracket.

Separately.... How would you even go about filing taxes for your kids? I'm using H&R Block software for DW & I (free through the military), but I don't think I can use the same program for them. Is it literally just like filing taxes for myself, except I would run through some tax software as if I were my kids/on their behalf? (1, 5, 7 y/o .... so they're obviously not doing it themselves). If so, would they (filing for "themselves") be eligible for the IRS FreeFile program (with miniscule >$4k incomes), or ineligible due to my income within the household? The situation is unclear on the FreeFile webpage.

[LivingAlmostLarge]

first year to file kids has to be paper. Then you can file using software. I don't know i've always just done the kids. I tax loss harvested a few years ago and then have written off the gains. One of my kids has a large, large gain on apple stock and boy is it going to hurt when she sells it. It's basically all gain and i've never sold it since DH uncle gave her 2 shares in 2010.

[MonkeyMama]

first year to file kids has to be paper. Then you can file using software.

I was going to say, "What on earth are you talking about?" but I see that is real. When did that become a thing?
Just what we need, more red tape and more wonky tax rules.

[MonkeyMama]

Okay, new Kiddie Taxes question, centered on optimizing it ... because I know it's a factor this year.

Separately.... How would you even go about filing taxes for your kids? I'm using H&R Block software for DW & I (free through the military), but I don't think I can use the same program for them. Is it literally just like filing taxes for myself, except I would run through some tax software as if I were my kids/on their behalf? (1, 5, 7 y/o .... so they're obviously not doing it themselves). If so, would they (filing for "themselves") be eligible for the IRS FreeFile program (with miniscule >$4k incomes), or ineligible due to my income within the household? The situation is unclear on the FreeFile webpage.

You can just use the H&R software for your kids too. I buy H&R because there are 5 free e-files. Which is perfect because I file for our parents, us, and each of our kids.

I looked into freefile options when I left my last tax job (no more free tax software) and was unable to file for our kids. I don't remember off the top of my head, but was probably because they had investment income, something like that. Or because they were dependents. Those are the two obvious reasons why they could probably not utilize.

[MonkeyMama]

Is it literally just like filing taxes for myself, except I would run through some tax software as if I were my kids/on their behalf? (1, 5, 7 y/o .... so they're obviously not doing it themselves).

Yes

[kork13]

first year to file kids has to be paper. Then you can file using software.

I was going to say, "What on earth are you talking about?" but I see that is real. When did that become a thing?
Just what we need, more red tape and more wonky tax rules.

Interesting wrinkle, I haven't seen that anywhere, what source did you find?

Thank you both for the help, seems almost silly to be lost about it...

[LivingAlmostLarge]

My own. When I first filed my kids separately and I do it yearly it had to be paper.