Exposing the Hidden Repeal within the SECURE Act

While the focus of the recently passed SECURE Act is greater retirement plan access and information, hidden within the Act is a provision that repeals the changes made to the Kiddie Tax by the Tax Cuts and Jobs Act of 2017 (TCJA).  This repeal may have financial benefit for parents who were affected two years ago.

Historically, the Kiddie Tax applied to all children 19 and under and children who are dependent, full-time students between the ages of 19 and 23.   A child’s salary or wages earned are taxed at the child’s individual tax rates; unearned income a child receives from income-producing property (or investment property), such as cash, stocks, bonds, mutual funds and real estate, is taxed at the parent’s tax rates.  This was designed to discourage wealthy parents from putting investment assets in a child’s name and having the unearned income from the assets taxed at rates lower than their own.

The TCJA went one step further and taxed a child’s unearned income at trust income tax rates.  Trust rates reach the highest tax bracket of 37% at $12,950 of income versus $622,050 for married couples.  Lawmakers believed this to be a better way to simplify the Kiddie tax reporting and capture income at higher rates while preventing wealthy parents from manipulating their income tax rates.

Unintended Consequence

The unintended consequence of this Kiddie Tax change caused survivor benefits received by children of servicemembers who died in active service, or Goldstar families, to be taxed at these higher trust tax rates.  As a result, for low- or middle-income Goldstar families, the child’s benefits were taxed at rates that were significantly higher than the surviving parent’s tax rate.

Congressional Fix

Once this came to light, both houses of Congress looked to address this anomaly.  The Senate passed legislation that would simply treat the survivor benefits as earned income which would have taxed the benefits at the child’s tax rates.  However, this called into question if other survivorship benefits paid to children should be considered earned income.  Lawmakers resolved the Goldstar issue by simply repealing the TCJA Kiddie Tax changes in the SECURE Act.

Action Steps for Parents

While the TCJA Kiddie Tax provision is effective for the 2020 tax year, the SECURE Act also allows taxpayers to retroactively apply this repeal to the 2018 and 2019 tax year.  This is a good example of politicians getting something right on both sides of the aisle.

If you were subject to Kiddie Tax reporting in 2018, you should consider filing an amended return to claim a refund of any excess tax.  There is a good chance that the parent’s income tax rate is lower than the trust income tax rates. For 2019 and thereafter, Kiddie tax planning becomes no different than in prior years. The disincentive to shift income to your children remains but isn’t as punitive as under the TCJA.

Parents affected by the change in 2018 should talk to their advisor about revisiting 2018 returns.   Budros, Ruhlin & Roe prides itself in following changing legislation and how it impacts our clients, and we’d be happy to talk with you about our wealth management services as well.

John D. Schuman, JD, CFP®, CPA (inactive)                                

Chief Planning Officer and Chief Compliance Officer / Co-CEO

President Scott Rister Named to Leadership Trust

Columbus Business First named Scott Rister as a 2020 Leadership Trust member.  It’s an invitation-only community for top business decision makers in Columbus.   Scott was selected for his depth of leadership in the financial services industry, most recently working almost 20 years with Charles Schwab & Co prior to joining Budros, Ruhlin & Roe.  His passion for encouraging financial education and diversity in thought are relevant in today’s business landscape.

“Columbus’ thriving business community is powered by leaders like Scott,” said Nick Fortine, president and publisher of Columbus Business First.  “We’re honored to be creating a space where the region’s business influencers come together to increase their impact on the community, build their businesses and connect with and strengthen one another.

Watch for more from Scott in articles, panels and forums.  Congratulations, Scott, on this honor.

What the SECURE Act Means for You

As expected, the Setting Every Community Up for Retirement Enhancement Act (“SECURE Act”) has become law after passing as part of the recent spending bill.  The House of Representatives approved it in early 2019 with bipartisan support, but the legislation was held up in the Senate until now.  Let’s look at a high-level view of what the SECURE Act means for you.

 

LEGISLATIVE INTENT

The intent of this legislation is to make retirement plans more accessible and give participants in retirement plans greater information.  For example, the SECURE Act expands participation to part-time employees, allows for IRA contributions after age 70½, requires plans to provide participants an annual estimate of the monthly payments received if the account were annuitized and allows annuities to be offered by plans.  Clearly, the insurance lobby was instrumental in this aspect of the SECURE Act.

IMPACTS REQUIRED MINIMUM DISTRIBUTIONS FOR NEXT GENERATION

The most impactful aspect of the SECURE Act for our clients is the change made to required minimum distributions from retirement plans beginning in 2020.  The Act basically eliminates the “stretch” out opportunities of an IRA paid to children and grandchildren.   We have counseled that an outright gift of your IRA to a child allowed your child to take minimum distributions over their life expectancy. For example, if a child is age 50 upon the parent’s death, the account could be distributed over approximately 34 years or more.

Under the SECURE Act, the account will need to be completely distributed over no more than 10 years. The Act provides a few exceptions to this 10-year payout: 1) minor children (until age of majority), 2) disabled and chronically ill individuals, and 3) individual not more than 10 years younger than the participant.

The SECURE Act foundationally supports the thinking that IRA and retirement accounts are designed for the benefit of spouses and not for the benefit of the next generation of the family.  Essentially, there is no change to how IRAs and retirement plans are left between spouses. A surviving spouse can still rollover an IRA inherited from his or her spouse. The major difference you’ll see from the SECURE Act is in benefiting children and grandchildren and only applies to those who begin to take minimum distributions in 2020 and beyond.

 

IMPACT WHEN TRUST IS BENEFICIARY

This 10-year payout has significant impact on IRAs that name trusts as beneficiaries.  Many clients name trusts as the beneficiary of their IRA to provide management and control of the assets for children.  The concern is trusts’ income tax brackets are significantly compressed, meaning income gets to the highest bracket very quickly (at about $13,000).  As the SECURE Act increases payout amounts, these amounts will be in higher brackets.

In addition, many trusts were designed to immediately pass out the anticipated small amount of minimum distribution based on life expectancy to avoid the trust’s income tax.  Based on the new 10-year rule, these trusts are going to be sending a much larger amount out to the beneficiary, undoing the management and control desired by the client.

 

NEW REQUIRED MINIMUM DISTRIBUTION START DATE

For those who have not yet been required to take a distribution, one benefit of the new SECURE Act is the start date of taking required minimum distributions.  Now, minimum distributions don’t have to start until age 72 (instead of 70 ½).  This gives some extra time for deferral of income taxes as well as more opportunity for Roth conversion planning in lower income tax years.

Any change in tax law requires attention and review.  We are working with clients to address how this new tax law impacts planning of retirement plan assets and help implement any changes to beneficiary designations.  The SECURE Act also calls into question whether Roth conversions of retirement assets have a broader application to clients and their beneficiaries.

Should you be in the market for a wealth management firm to counsel you in financial planning and monitoring issues like these, consider Budros, Ruhlin & Roe and put our 40 years of experience to work for you.

John D. Schuman, JD, CFP®, CPA (inactive)