How the Kiddie Tax, 529 Plans Were Changed by SECURE Act

Some significant changes in family income tax planning were included in the Setting Up Every Community for Retirement Enhancement (SECURE) Act enacted late in 2019.The biggest change is the reversal of the Kiddie Tax rules.

The Kiddie Tax was overhauled in the Tax Cuts and Jobs Act (TCJA) enacted late in 2017. The Kiddie Tax is a series of provisions that determine how unearned (investment) income of people under age 19 is taxed. For many years, the investment income of youngsters was taxed at their parents’ highest marginal tax rate.

The TCJA changed the rules for 2018 and later years so that the unearned income of youngsters was taxed without reference to their parents’ tax rates. Instead, youngsters used the tax table for trusts and estates.

One of the problems with the TCJA rules was that the trusts and estates tax table gets to the highest tax rate much faster than the tax tables for other taxpayers. The change in the rules increased the income taxes on many youngsters.

There were other problems.

The TCJA increased taxes on scholarships and stipends some students used to pay for non-tuition expenses. Surviving children of military members killed in action, known as Gold Star families, also received higher tax bills on survivor benefits under the TCJA.

The SECURE Act corrects all this by repealing the TCJA changes to the Kiddie Tax and restoring the pre-2018 rules for taxing unearned income of taxpayers under age 19. Unearned income up to $2,200 is taxed at the child’s rate and avoids the Kiddie Tax. Income above $2,200 is subject to the tax and taxed at the parent’s highest tax rate. You can find details about these rules in our April 2016 issue.

The TCJA Kiddie Tax rules are repealed retroactively at the option of taxpayers. Under the SECURE Act change, taxpayers can choose to use the pre-TCJA rules for their 2018 and 2019 tax returns. If the 2018 tax return already was filed using the TCJA rules, it can be amended using the pre-TCJA rules. But taxpayers who prefer can use the TCJA rules on their 2018 and 2019 tax returns.

Another recent change affecting family income taxes was the restoration of the deduction from gross income of up to $4,000 for tuition paid by the taxpayer for himself or herself, a spouse and any dependents. The deduction expired at the end of 2017 but was reinstated retroactively. Eligible taxpayers should consider filing amended returns for 2018 to claim refunds.

The deduction is available only to middle and low-income taxpayers. Only expenses of tuition and mandatory fees qualify for the deduction.

Some changes to 529 education savings plans also were included in the SECURE Act.

The major change probably is that 529 account distributions can be used to pay student debt. But there’s a big limit. Only $10,000 of 529 funds per beneficiary can be used to pay student debt, and that’s a lifetime limit, not an annual limit. But up to $10,000 of additional money from the 529 plan can be used to pay the student debt of each of the account beneficiary’s siblings.

The money can be used to pay either interest or principal. But if the 529 money is used to pay interest on a student loan, the interest doesn’t qualify for the above-the-line deduction for student loan interest.

Another expansion of 529 accounts is account balances now can be used to pay for apprenticeship programs. The program and its sponsor must be registered with the U.S. Department of Labor to be eligible to receive 529 funds.