At Fleming & Curti, PLC, we frequently act as fiduciary. That means we handle money held in trusts, conservatorships and individual names. It also means we file tax returns — lots of them. We have just completed (mostly) the 2018 tax filings, and we have some insights into how the 2017 Tax Cut and Jobs Act has affected income taxes for real people — and trusts.
Your mileage may vary
Of course, the effect of the federal tax cut may be very different for different taxpayers. The sample we deal with is different from the average taxpayer. One key difference: we see a lot of young people with substantial personal injury settlements. That group, especially, was hit hard by the new tax law.
Still, the numbers are interesting. We filed about the same number of tax returns this year as in 2018 (that is, for 2017). We saw a wide spread in incomes — everything from negative numbers to over a half million dollars. Many, but not all, of the returns included large medical deductions.
So what are the numbers?
The average amount of tax paid in 2017 across all of our returns: a little over $28,000. For 2018, that number dropped to just under $17,000. In all, that meant about a 42% decrease in average tax liability.
In fairness, though, that was based on a slightly lower total income for the year. The total income was down about 20%. Why? Well, that’s actually another interesting question — and the answer is not really about investment experience or interest rates. More on that in a minute.
A better test of the effect of the Tax Cut and Jobs Act is probably to look at effective tax rates. For all of the returns we prepared, filed or reviewed in 2017, the average tax rate was just over 5%. In 2018, that number actually rose — to just a shade under 10%. That figure ignores those returns that paid no tax at all — a little less than half of all returns in each year.
But didn’t the Tax Cut and Jobs Act decrease taxes for most individuals? Yes, it did. But there’s one category that explains much of our office experience.
Introducing: the Kiddie Tax
Back in the dark ages (OK — thirty years ago), children paid tax on their income at their own tax rates. That presented an opportunity for wealthy families to reduce their taxes. All the parents would have to do would be to transfer income-producing assets to their minor children; they could still keep control in the family, and the kids’ tax rates would be lower, at least until they graduated from college and went to work in the family business.
In 1986, Congress tried to close what it saw as a loophole. Since it targeted high-income children, it immediately got nicknamed “the Kiddie Tax.”
Initially, the new tax applied only to children under age 17. The congressional solution was elegant: a minor child’s tax rate would be pegged at the higher of the child’s own rate or the parents’ rate. That way child stars (remember Webster and Punky Brewster?) could pay higher taxes on their investment earnings, while the children of millionaires could not capitalize on their relatively lower incomes.
In 2006, the coverage of the Kiddie Tax expanded to age 18. Two years later, it expanded again — youngsters would pay the higher tax until age 23 if they were full-time students.
One problem with the Kiddie Tax from its inception: in order to complete the child’s return, her tax preparer would need access to her parents’ returns. That made completion of tax returns for children challenging, at least.
Applying the Kiddie Tax to our cases
But most of the youngsters for whom Fleming & Curti, PLC, prepares or reviews returns are not wealthy because of on-screen charisma or lucky parent selection. Because they were seriously injured in an accident, or by medical malpractice, they received significant settlements. They also tend to have large — often even huge — medical and care costs. Those children often earn more than their parents, so getting those parental tax returns — though required — never made much difference.
Along comes the Tax Cut and Jobs Act of 2017. It offers to make calculating the Kiddie Tax easier. Rather than basing the tax level on the parent’s income, we can now just use one benchmark. Unfortunately, Congress chose the benchmark that results in the highest possible tax liability for children with income. The Kiddie Tax is no based on the tax level imposed on trusts and estates — and that maxes out at 37% after just $12,500 of taxable income.
To compound the issue, the Tax Cut and Jobs Act also stripped away a number of deductions that previously applied to conservatorship or trust accounts like those we usually manage. The result: the new tax rates hurt youngsters with serious injuries and income-producing assets awarded precisely to help them pay for their care needs.
So what happens to the Fleming & Curti, PLC, tax returns if we take out all those minor beneficiaries? The average tax rate plunges to below 2% in 2018 — about half of the average rate for 2017.
Should a tax cut result in tax increases for seriously injured children? We didn’t think so, but that’s how it looks.