The Kiddie Tax Needs a Better Fix Pt. 2

By Sam Brunson

As I explained in my previous post, the new kiddie tax is an absolute mess, with unintended and (I assume) unforeseen consequences that significantly harm, among others, poor college students and the children of service members killed in action. How is Congress going to fix this?

Poorly, I assume. And insufficiently.

I saw on Twitter yesterday that Rep. Cindy Axne is cosponsoring the Gold Star Family Tax Relief Act. Under the proposed legislation, the definition of “unearned income” will exclude survivor benefits received by the children of deceased service members. If this legislation were to pass, children of military members killed in action would no longer pay taxes at the top marginal rate on their survivor’s benefits.

I don’t know that this is an uncommon approach. Congress likes to make little fixes that benefit popular and politically-salient groups. They did it for Olympic medalists. And in 1986, Congress codified a number of tax benefits that military members had previously enjoyed.

But come on. This is a really weak fix to the problems the TCJA introduced to the kiddie tax. I mean, the one single benefit was that the TCJA simplified the kiddie tax. And now Congress wants to add complexity back into the Code.

Besides adding complexity, the Gold Star Family Tax Relief Act doesn’t solve the problems the TCJA introduced. Sure, it helps military children. But only with survivor benefits. When and if those children get scholarships, they’ll be subject to the kiddie tax on those scholarships. Moreover, if the Gold Star children invest the benefits they receive, they’ll be subject to the kiddie tax on their returns from those investments.

The proposed legislation papers over one single problem raised by the new kiddie tax; Congress appears content to leave the rest of the problems in place.

And Congress seems utterly uninterested in whether the kiddie tax solves the problem it was enacted to solve, or even if that problem still exists. Does the new kiddie tax reduce the incentive of wealthy parents to shift income-producing assets to their children? As I explain in Meet the New Kiddie Tax: Simpler and Less Effective, for higher-income parents, there is less disincentive than there was under the previous kiddie tax. In fact, the new kiddie tax is far more regressive (as the New York Times and the Wall Street Journal illustrate) than the old kiddie tax was.

So what should Congress do? I think it should eliminate the kiddie tax altogether or, if it believes income-shifting is still a problem, target it more closely so that it only applies to income from property transferred to a child by her parents (or maybe grandparents).

Short of that, though, it should at least revert back to the original kiddie tax. That regime was certainly imperfect, but it was less regressive and better-aligned with the foundational goals of the kiddie tax. And reverting back is an easy solution: under current law, the new kiddie tax goes away after 2025. Why not just move that date up to 2017?