How the Kiddie Tax Impacts Scholarship Recipients

Understanding the Kiddie Tax and its Impact on Scholarship Recipients

Have you ever heard of the kiddie tax? It’s a tax law that was introduced in 1986 to prevent parents from transferring large amounts of investment income to their children. This tax law was recently changed as part of the Tax Cuts and Jobs Act (TCJA) of 2017. Let’s take a closer look at how the kiddie tax impacts scholarship recipients.

What is the Kiddie Tax?

The kiddie tax is a tax on the investment income of children under the age of 19 or full-time students under the age of 24. Typically, investment income received by children is taxed at a lower rate than their parents. To prevent parents from taking advantage of this lower tax rate, the kiddie tax was created to ensure that a child’s investment income is taxed at the same rate as their parents’ income.

How the Kiddie Tax Impacts Scholarship Recipients

Under the TCJA, the kiddie tax now uses the tax rates that apply to estates and trusts. The new tax rates are much higher than the previous rates and can impact scholarship recipients in two ways.

Firstly, if a scholarship recipient has investment income, their tax rate will now be much higher. This is because the tax rate on investment income for estates and trusts is much higher than the income tax brackets for individuals. Therefore, scholarship recipients who have investment income might see a significant increase in their tax bill.

Secondly, if a scholarship is used to pay for tuition fees, books, or any other qualifying expenses, it’s tax-free. However, if there are any leftover funds, and the scholarship recipient invests the money, they may be subject to the kiddie tax on the income generated from those investments.

Example

Let’s say that John, a full-time scholarship recipient, receives $10,000 in scholarship money and uses $8,000 to pay for tuition, books, and qualifying expenses. He decides to invest the remaining $2,000 in stocks. The stocks generate $200 in investment income during the year. Under the TCJA, John’s tax rate on the $200 in investment income will be the same as a trust or estate tax rate, which is 37%.

Conclusion

In conclusion, the kiddie tax is designed to prevent parents from transferring large amounts of investment income to their children. The TCJA has made significant changes to the tax rates of the kiddie tax. Scholarship recipients who receive investment income or have leftover scholarship funds that generate investment income are likely to be impacted by these changes. As a scholarship recipient or parent, it’s important to understand how the kiddie tax affects your tax bill and plan accordingly.