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Taxes: Kiddie Tax and Extending Expired Tax Provisions

By Anthony P. Curatola and James W. Rinier, CPA, EA
March 1, 2020
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The Further Consolidated Appropriations Act, 2020 changes how children’s net unearned income is taxed under the Tax Cuts and Jobs Act of 2017 and extends several expired individual tax provisions to the 2020 tax year.

 

The Further Consolidated Appropriations Act, 2020 (FCAA) was signed into law on December 20, 2019. As a large consolidated appropriations act, it’s separated into 17 legislative acts (Divisions A through Q). Within the FCAA, the Taxpayer Certainty and Disaster Tax Relief Act of 2019 appears in Division Q (Revenue Provisions) and extends certain expiring provisions. In addition, the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE) appears in Division O and, among a number of changes, provides a revision to the calculation of tax on a child’s unearned income.

 

KIDDIE TAX CHANGES

 

Internal Revenue Code (IRC) §1(g) contains special rules for calculating the federal income tax on a child’s unearned income (also known as the “kiddie tax”). Prior to 2018, a child’s net unearned income was added onto the parent’s taxable income and therefore taxed at the highest marginal tax rate. The Tax Cuts and Jobs Act of 2017 (TCJA) had changed this tax provision by allowing a child’s net unearned income to be calculated independently of the parent’s income.

 

As was added by the TCJA, IRC §1(j), Modifications for Taxable Years 2018 through 2025, the applicable tax rates for the child’s net unearned income is based on the trust and estate’s tax rate brackets and modified by the addition of the child’s earned taxable income to each of those brackets.

 

Specifically, IRC §1(j)(4)(D), which was added by the TCJA, states that “earned taxable income” now means “the taxable income of such child reduced (but not below zero) by the net unearned income.” Note a subtle difference in the wording under the TCJA in that the IRC specifies “earned taxable income,” which isn’t the same as earned income.

 

Under Act §501 of the FCAA (Division O), the kiddie tax provisions set forth in the TCJA are repealed for tax years beginning after December 31, 2019. That means the unearned income of a child is once again added to the parent’s taxable income (as it was before the TCJA) beginning with tax year 2020.

 

One must be careful in their tax research of the tax code because IRC §1(j)(4), which was previously added by the TCJA, is now listed as being “[Stricken]” because the FCAA took that section out and it can’t be found in the current tax code. One may have to look at the history notes of the IRC to see the language of IRC §1 before IRC §1(j)(4) was removed to see that this repeal is effective generally for tax years beginning after December 31, 2019, and to see the law as written by the TCJA before the FCAA in the IRC.

 

In addition, for the kiddie tax, Act §501(c)(3) provides an elective retroactive application of the new law (that went back to the old law before the TCJA). That is, a taxpayer may revisit tax years 2018 and 2019 and recalculate the child’s unearned income under the pre-TCJA rules as the Secretary of the Treasury or the Secretary’s designee may provide. Obviously, a taxpayer would only file an amended return if a lower tax results from the application of the pre-TCJA rules.

 

Finally, Act §501(b) eliminates the reduced alternative minimum tax (AMT) exemption amount when applying the kiddie tax rules for those children with net unearned income. And per Act §501(c)(2), this provision applies to taxable years beginning after December 31, 2017. Thus, a taxpayer that could be subject to the AMT regarding the kiddie tax may have to revisit tax year 2018 and watch out in tax year 2019.

 

PRINCIPAL RESIDENCE DISCHARGE OF INDEBTEDNESS

 

IRC §108(a) provided that, under certain circumstances, gross income doesn’t include amounts that would be a taxable discharge of indebtedness. Generally, when a taxpayer is forgiven a debt (for example, the discharge of any amount owed to a credit card company), that creates taxable income. One of those exclusions included qualified principal residence indebtedness that is discharged but had an expiration date (IRC §108(a)(E)) for debts discharged after December 31, 2017. This provision is limited per IRC §108(h)(2) to $2 million ($1 million if married filing separately) of forgiven acquisition mortgage debt of a taxpayer’s principal residence.

 

Congress justified the addition of this exclusion in 2007 (see HR 110-356) because it was considered inappropriate to treat discharges of the acquisition indebtedness as income when taxpayers restructure their acquisition debt on a principal residence (or lose their principal residence in a foreclosure).

 

This provision has been extended several times. Under Act §101 of the FCAA (Division Q), the exclusion per IRC §108 is retroactively extended from January 1, 2018, to debts discharged prior to January 1, 2021.

 

MORTGAGE INSURANCE PREMIUM DEDUCTION

 

In general, personal interest isn’t deductible for individual taxpayers. One exception was provided in IRC §163(h)(3)(E) for mortgage insurance premiums paid by taxpayers with an adjusted gross income (AGI) less than or equal to $100,000 ($50,000 for married, filing separate) and phased out by 10% for each or a fraction of each $1,000 ($500 for married, filing separate) of AGI greater than $100,000.

 

This tax provision had been extended several times and had expired for mortgage insurance premiums paid or accrued after December 31, 2017. Yet Act §102 of the FCAA (Division Q) has retroactively extended IRC §163(h)(3)(E)(iv)(I) once again to apply to amounts paid or accrued up to and including December 31, 2020.

 

MEDICAL EXPENSE FLOOR

 

As part of the 2010 Patient Protection Affordable Care Act, the 7.5% threshold for taxpayers claiming medical expenses was increased to 10%, with a special rule for those taxpayers age 65 or older by year end (IRC §213). The special rules retained the 7.5% threshold for this group of taxpayers for tax years 2013 through 2016. Therefore, all taxpayers regardless of age were subject to the 10% threshold level beginning in 2017.

 

Act §11027 of the TCJA reset the percentage to 7.5% for tax years 2017 and 2018 for all taxpayers, and the percentage was scheduled to increase to 10% for tax years beginning January 1, 2019, for all taxpayers. Section 103 of the FCAA (Division Q) has retroactively reset the percentage for all taxpayers to 7.5% for tax years beginning January 1, 2019, up to January 1, 2021 (IRC §213(f)).

 

TUITION AND FEES DEDUCTION

 

Prior to taxable years ending December 31, 2017, a taxpayer could claim an above-the-line deduction for up to $4,000 for qualified tuition and fees paid on behalf of the taxpayer, a spouse, or their dependents. The $4,000 limit was phased out if the taxpayer’s AGI exceeded $65,000 ($130,000 on a joint return). A $2,000 deduction limit was established for those taxpayers with an AGI between $65,001 and $80,000 ($130,001 and $160,000 on a joint return). No deduction was available for all other taxpayers, including those electing a file status of married, filing separate, or those individuals whereby the personal exemption deduction could be claimed by another taxpayer.

 

FCAA §104 (Division Q) retroactively extends this provision from taxable year 2018 to 2020 and shall not apply to taxable years beginning after December 31, 2020 (IRC §222(e)).

 

© 2020 A.P. Curatola

Anthony P. Curatola is editor of the Taxes column for Strategic Finance, the Joseph F. Ford Professor of Accounting at Drexel University in Philadelphia, Pa., and a member of IMA’s Greater Philadelphia Chapter. You can reach Tony at (215) 895-1453 or curatola@drexel.edu.
James W. Rinier, CPA, EA, is an assistant clinical professor of accounting at Drexel University. He can be reached at jwr29@drexel.edu.  
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