The Tax Cuts and Jobs Act of 2017 moved through Congress and was signed into law at breakneck speed. While many got what they wanted in the new tax law, Indian Country was again disappointed by the lack of inclusion of provisions that would put tribes on an equal footing with sovereign nations. To make matters worse, modifications of the "Kiddie Tax" had unintended and harmful consequences for some Native American children and young adults. As Congress looks at next steps on tax reform, these issues must be addressed.
The Kiddie Tax became part of the Internal Revenue Code in 1986. Its purpose was to stop wealthy parents from lowering their taxes by putting income-producing investment property in their children's names. The tax received its nickname because it originally applied to children under age 14. The age limitation was increased in 2007 to apply to many "kiddies" up to age 23. Generally speaking, the Kiddie Tax applies to unearned income (e.g., income other than wages or compensation for services) over a threshold amount and (prior to the Tax Cuts and Jobs Act) taxes it at the rate the parent would pay if it were the parent's income.
In the name of simplification, the Tax Cuts and Jobs Act applied the Kiddie Tax to more taxpayers at higher tax rates. Rather than look to a parent's tax rate, the Kiddie Tax is now pegged against the rate applicable to estates and trusts – which stands at 37 percent for amounts of unearned income of more than $12,500.
Unearned income subject to the Kiddie Tax has long been understood to include per capita distributions made by tribal governments to their tribal members. Per capita payments are the distribution of tribal revenue to an individual tribal member on a per capita basis and are derived from a number of sources, including gaming, allotted tribal lands, rents or royalties, and the sale of resources. All per capita derived from gaming and certain other activities is taxable. Often, these per capita payments are used by young tribal members to attend college or purchase their first home.
However, the modifications to the Kiddie Tax in the Tax Cuts and Jobs Act of 2017 will in some instances increase the tax rate and thus the overall amount of tax due from many tribal members receiving these distributions. In many cases, this has an unintended consequence of doubling or tripling the tax rate paid by young Native Americans on financial support they receive from their tribal governments.
For example, if a 20-year-old Native American student earns $18,000 from a part-time job in 2018, she would pay tax at an effective rate of 10 percent. But if she received that $18,000 as unearned income as a per capita payment from her tribe, she would be in the top tax bracket for trusts and estates of 37 percent and pay tax at an effective rate of 26 percent – a difference of almost $3,000.
To make matters worse, both the 1986 Tax Reform Act and the 2017 Tax Act applied the Kiddie Tax to unearned income of children under age 18, unless they are full-time students, in which case it applies to unearned income of children and young adults up to age 23. Thus, Congress has structured the law in a way that encourages individuals to drop out of school. The effects of this perverse incentive is particularly felt in Indian Country, where the tax burden associated with per capita payments is significant.
From a tax policy perspective, the Kiddie Tax should not be applied to transfers of tribal funds to tribal youth and young adults. Tribes do not pay income tax. Thus, the transfer of tribal funds from tribes to their younger tribal members is never motivated by a desire to shelter tribal income from tax or to gain a tribal benefit from a reduced tax rate. Rather, transfers are made to tribal members in furtherance of tribal general welfare and sovereignty as well as to ensure that tribal members have the resources they need to attend school, among other things.
To date, attempts to exempt tribal distributions from the Kiddie Tax have been unsuccessful. Common sense and basic fairness requires that Congress amend the Kiddie Tax provisions to expressly exclude the transfer of funds by a tribal government to young tribal members. If such a fix were made, the amounts received by younger tribal members would remain taxable, just not at the higher tax rates for trusts and estates.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.
Please note that email communications to the firm through this website do not create an attorney-client relationship between you and the firm. Do not send any privileged or confidential information to the firm through this website. Click "accept" below to confirm that you have read and understand this notice.