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The SECURE Act and Settlement Planning

John Darer • Jan 31, 2020

"Here's Looking At You Kiddie" and the New "Rule of 72"

Kiddie Tax

What is The Secure Act?

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in December 2019, includes many bi-partisan reforms that increase access to workplace plans and expand retirement savings. Generally, the retirement legislation includes policy changes that will impact defined contribution (DC) plans, defined benefit (DB) plans, individual retirement accounts (IRAs) and 529 plans. But there are a couple of areas where the SECURE ACT may intersect with personal injury settlement planning in addition to planning  for certain non-personal injury claimants and financial planning for lawyers. January 1, 2020 was the effective date for most of the provisions of the SECURE Act.

Kiddie Tax Rates under TCJA Repealed

What is The Kiddie Tax Rule?
The so-called Kiddie Tax originated in the Tax Reform Act of 1986, P.L. 99-514, as a solution to counter a popular tax-saving strategy for high-income families of funneling their unearned income through their children to reduce their overall taxes in the 1980s. The Kiddie Tax served to limit the effectiveness of parent-children income shifting, by taxing certain amounts of children's unearned income at a very high rate.

What Does The Repeal Mean?
The SECURE Act repeals the draconian application of trust tax rate schedule to unearned income of a minor that was charged pursuant to the Tax Cuts and Jobs Act of 2017. The quick ramp up in trust tax rates saw the 37% rate applied at $12,950 for 2020.  But a single taxpayer or single and head of household in 2020, would not reach that level until an income level of $518,401 taxable income levels.  Moreover a married couple , filing jointly would not reach that level until reaching taxable income of $622,051. Prior to TCJA unearned income above a certain threshold was taxed at the parent or parents'  (as applicable) marginal tax bracket. The repeal restores the prior methodology. 

The kiddie tax rule found at IRC § 1(g), means (again) "taxes certain unearned income of a child at the parent's marginal rate, no matter whether the child can be claimed as a dependent on the parent's return".

What Does Unearned Income Mean?
Unearned income for purposes of the Kiddie Tax means income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. So among other things, unearned income includes capital gains, dividends, and interest.

How do structured settlements help mitigate kiddie tax issue?

Where minor dependents are receiving structured settlements that represent damages on account of physical injury, physical sickness or wrongful death, the payments are income tax free.  They are not part of kiddie tax calculations.   Therefore an allocation to structure may be helpful.

New "Rule of 72"  | Require Minimum Distribution Start Date Extended

Instead of having to begin withdrawing money from retirement plans at age 70.5, the plaintiff can continue to defer for an additional 18 months to age 72 before withdrawals must begin. Deferring gives an opportunity to earn more tax deferred growth.  The amount you must withdraw is determined by dividing the balance of each qualifying account by your life expectancy as defined by the IRS. A tax-free payment stream from a personal injury or wrongful death structured settlement could help the plaintiff better "afford" to defer the start of taxable income.  Widows and widowers, older children survivors in a wrongful death case, older claimant in general may benefit the most from this new opportunity. If you're in decent health and have good longevity in your family, you can also use a structured settlement payment stream to delay taking social security until 70 to maximize your benefit. 

The SECURE Act also eliminates stretch IRAS, which allowed the inheritance of an IRA that could then be stretched over the beneficiary's life expectancy. Beginning with deaths of 401k and pension plan participantswners or IRA ownersplan participants or IRA owners in 2020, distributions must generally be taken over the following 10 years.

Deferring gives an opportunity to earn more tax deferred growth.

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