Broker Check

Tax Reform and Families: 3 Essential Changes

August 02, 2019

There is both good and bad news for families in the new tax act.
About 60% of the tax cuts will go to families, so understanding these
changes is essential.
If you are struggling to understand the new tax act
and how it will affect you, so are millions of American
families! Indeed, there is both good and bad news. With
about 60% of the tax cuts going to families, according to
the federal government, you need to understand how to
get the best for your family.

1. The child tax credit has improved
The child tax credit was originally designed to help
working families with the costs of raising their children.
Prior to the new law, the child care credit was $1,000
per child, phasing out when a taxpayer’s AGI exceeded
$75,000 for single filers and $110,000 for married
couples filing jointly.

Under the new law, taxpayers can now claim up to
$2,000 for each child under age 17. The credit won’t
phase out until a single filer’s income is $200,000 and
$400,000 for those married couples filing jointly. This is
a huge difference!

This change in the phase-out limit will allow more
middle- and upper-income families to claim the credit
(but they took the additional exemptions for children
away, so they are trying to make up for it here.) Up to
$1,400 is refundable, meaning a taxpayer can receive
money back even if taxes are not owed.

This is beneficial for all income levels, especially those
who do not owe any tax. Because the tax credit is
doubled and up to $1,400 is fully refundable, families
will likely have more money in their pockets. However,
families will now need to provide their child’s Social
Security number to receive the credit. Prior to the act,
taxpayers did not need to provide this information.

Taxpayers can also reduce their tax bill by $500 for
other dependents who are not children, such as elderly
parents. This nonrefundable credit is an incentive for
families to take care of loved ones other than children.

2. New calculation for the kiddie tax
On a related note, there is a change to the way the
“kiddie tax” is calculated. Previously, a child’s net
unearned income over $2,200 was taxed at the parent’s
top marginal rate. Under the new law, ordinary and
capital gains rates applicable to trusts and estates are
applied to the net unearned income of a child.

For example, let’s say a child has unearned income from
an UTMA of $5,000 that is subject to the kiddie tax and
the parents have taxable income of $80,000. The tax
rate of the parents is 25%.
Prior to the act, this amount is taxed at the parent’s
highest tax bracket of 25%, thus the child would owe
$1,250 in taxes. In 2018 and later, the rates for trusts
and estates apply. For the same family, under the new
tax laws which apply the trust and gifts tax brackets, the
first $2,600 is taxed at 10% and the remaining $2,400 is
taxed at 24%. The result is a tax bill of $836.

3. 529 plans just got better
Section 529 plans are tax-advantaged savings vehicles
that have grown in popularity since they were created in
1996. According to the College Savings Plans Network,
529 plans account for $275 billion in assets. Previously,
529 plans were limited to payments for post-secondary
education. The new law allows a $10,000 annual
distribution from 529 savings plans (not prepaid tuition
plans) to pay for K-12 private or parochial education at
the elementary and high school level.

The new limit on state and local tax deductions up to
$10,000 per return will most likely make these accounts
even more appealing than ever, as they receive a state
tax deduction in certain states. Almost 36 states already
offer an income-tax deduction or credit for a 529 plan
contribution. New York and Connecticut allow a full
deduction for a contribution of up to $5,000 for a single
filer and $10,000 for a married couple filing jointly.
For example, if you live in New York and open a 529
plan and invest $10,000 for your child’s private school
tuition, you could avoid $600 in state income tax.

This is a boon for parents sending their children to
private school, however there are some downsides.
One disadvantage is that institutions may want to know
about 529 plans when making aid decisions. Also, you
will need to consider that withdrawing money from a
529 plan to pay for private school shrinks the time that
the assets can compound tax-free.

Of course, to take full advantage of a 529 plan, you need
to establish the account as soon as possible. Each state
has its own rules about contributions and distributions,
so be sure to check with your advisor. In some cases,
there may be penalties for withdrawals.

Also, you can now roll a 529 plan to a 529 ABLE account,
which provides tax advantages to people under the
age of 26 who are blind or disabled, without limiting
their ability to take Medicaid and Supplemental
Security Income benefits. Note that after the death of
a beneficiary, funds in an ABLE account can go to the
state to repay Medicaid benefits if they were receiving
these monies. The designated beneficiary of the 529
plan must already own an ABLE account.

While the tax act provides many benefits to assist
families, talking with a financial advisor is needed to
go through these new and ever-changing laws.