Category: Estate Planning

One part of the Tax Cuts and Jobs Act that has not received a lot of attention is the change of calculation for the so-called “kiddie tax”. This tax applies to children who have unearned income in excess of $2,100.  The kiddie tax applies to children age 18 and under or age 19-23 for full-time students whose earned income is less than or equal to 50% of their support.

Under the old law, unearned income in excess of $ 2,100 was taxed at their parent’s income tax rate but the new law subjects this income to the same rates as a trust. As a result, unearned income would hit the top tax rate of 37% at the very low income level of $ 12,500.  The parent’s rate would only be that high if the parent’s income is over $ 600,000.  Therefore, the strategy of grandparents leaving a grandchild a traditional IRA, with the goal of achieving a longer distribution period may not be as attractive as it used to be.

Given this new reality, what can be done to work around the “kiddie tax”?

  • You can still gift modest amounts to children in UTMA accounts and keep their investment income below $2,100 by investing in growth stocks vs. dividend payers.
  • If a college age child has already inherited a large IRA, then reduce their distributions to the minimum required, borrow money to cover tuition and then pay off the debt with larger distributions once the child turns 24.
  • Name older children (age 24 and above) as beneficiaries of your traditional IRAs. Younger children could still be beneficiaries of Roth IRAs.

Leaving traditional IRAs to children or grandchildren is still a viable strategy but care must be taken to avoid or minimize the kiddie tax.

 

 

David K. Raye, CPA, P.C.                     704-887-5298             www.davidrayecpa.com

 

*The information in this blog post is general in nature and not intended as specific advice.  Please consult a tax advisor to see how this information applies to your specific situation. 

The choice of beneficiaries for your IRA or other retirement plans is one of many financial decisions that must be made during your lifetime. Generally, the goal is to maximize the deferral period so that the account can continue to grow tax deferred as long as possible.  Here is a quick rundown of the rules applicable to different types of beneficiaries.

Surviving spouses are the most common beneficiaries and generally get the most favorable treatment.  A surviving spouse can:

  • Elect to treat an IRA as their own if they are sole beneficiary
  • Defer Required Minimum Distribution (RMD) until the year the decedent/owner would have turned age 70 ½. The spouse would then take RMDs based on their own life expectancy.

The timing of RMDs for non-spouse beneficiaries varies depending on whether the decedent had already begun taking RMDs themselves.  When an owner dies before this point, RMDs for a non-spouse beneficiary can be calculated over the beneficiary’s life expectancy.  When the owner dies on or after their required beginning date, RMDs for the non-spouse beneficiary will be calculated based on the longer of the beneficiary’s life expectancy or the deceased owner’s remaining life expectancy.  Distributions would be required to start by December 31 of the year following the owner’s death.

If there are multiple beneficiaries, the life of the oldest is generally used but this can be avoided by splitting the IRA into separate accounts.  Then each individual beneficiary can take distributions based on their own life expectancy.  Splitting the account is especially crucial if there is a large age gap between beneficiaries.

It is also important to name contingent beneficiaries.  These individuals would be next in line to receive the IRA assets if the primary beneficiary dies or disclaims their interest.  IRAs that include a non-person beneficiary such as a trust or charity must take out that entity’s share of the IRA by September 30 of the year following the owner’s death.

These are just some of the general rules applicable to this very complex area of tax law. For more information on inherited IRAs, please call my office.

 

David K. Raye, CPA, P.C.                     704-887-5298             www.davidrayecpa.com

 

*The information in this blog post is general in nature and not intended as specific advice.  Please consult a tax advisor to see how this information applies to your specific situation. 

A trust is a legal entity in which someone acting as a fiduciary holds property for the benefit of another.  Trusts are used extensively in the areas of financial and wealth management.  Most people think of trusts as something only used by the “super rich” but individuals and families of modest means would find them useful in their planning.  This post will explore some of the practical uses of trusts and discuss the taxation of trusts.

Purpose of trusts

Trusts can be used for various purposes including the following:

  • Protect property for beneficiaries
  • Provide income for minor children or others incapable of handling money
  • Control the distribution of assets after the grantor’s death
  • Save on estate taxes by removing appreciating assets from the grantor’s estate
  • Charitable purposes

Taxation of trusts

A trust is taxed much like an individual.  Trust income such as interest, dividends and capital gains must be reported on an income tax return (Form 1041).  However, there are some important differences in the taxation of trusts as compared to an individual.

  • Trusts do not get a standard deduction and their exemption amounts are much lower than individuals.
  • The rate brackets of a trust are compressed so that a trust may pay higher taxes than an individual. For example, the top individual tax rate of 39.6% starts at an income of only $12,500 for trusts vs. $ 415,050 for a single individual or $ 466,950 for a married couple.

The high rate of taxation caused by the compressed tax rate brackets can be avoided by distributing income to the beneficiaries.  In that case, the income would be taxed to the individual beneficiaries instead of to the trust.  This income would be reported to the beneficiaries on a Schedule K-1.

As you can see, it is usually not wise to accumulate income within a trust because of the high tax rates on retained income.  This income should instead be distributed to individuals who will usually be in lower brackets.  This distribution can be a good method to shift income to minor children who will typically be taxed at lower rates but watch out for the kiddie tax rules which can limit this technique (more about the kiddie tax rules in a future post!).

David K. Raye, CPA, P.C.

704-887-5298

www.davidrayecpa.com

*The information in this blog post is general in nature and not intended as specific advice.  Please consult a tax advisor to see how this information applies to your specific situation. 

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13850 Ballantyne Corporate Place, Ste. 500 Charlotte, NC 28277 Ph:(704) 887-5298

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