Kids inherited IRA, questions about RMDs

[AR]

So both of my kids (2 and 4 yo) recently received inherited IRAs.  They have to take some distributions every year.  Here are some questions I'm hoping someone can help me answer.

 

1. Taxes -- the RMDs will be around $2K.  How is this taxed?  I assume it will be taxed at the child's own income tax rate.  The have no other income, but it seems like they will probably still owe some tax on it.  Do I have to file separate returns for them?  Also as far as actually paying the tax, can I pay it for them, or does it have to come from them directly (e.g. a custodial account that I set up for them).  If I pay the tax for them is that considered a gift and does it eat into the 15K that I can otherwise give them.

2. Let's say that I put all of the RMDs each year into an custodial UGMA account which is invested 100% in Vanguard total market. How are the dividends in that account taxed.  My dividend rate or theirs?

3. I do not currently have any custodial accounts of any kind set up in their names.  Let's assume that I don't set one up. When I get the check for the RMD, can I deposit it in my checking account and just use it for their expenses (including taxes that are owed) or do I need to set up some sort of account in each of their names in which I can deposit the check (apparently at the brokerages at which these accounts are held, the only way I can get the RMD is via check in the mail).

 

 

 

[FIREshrink]

What year did the decedent die?

[AR]

FIREshrink wrote:

What year did the decedent die?

Click to expand...

2017

[jz]

I have only sketchy memory here, on recent readings.   Is this a stretch IRA?  an inherited stretch IRA?
Under new tax law, the children's investment income is taxed at their parents' rates up to $2,500 annually. Beyond that, the children's investment income is taxed at the maximal, ie 37%.   Or another interpretation would have them taxes at highest LTCG rates.    Help?      The brackets for children's investment income has become brutal.

[FIREshrink]

IRA distributions are unearned income. Google kiddie tax but they will not owe tax on that amount.

As you know the RMD for 2017 should have been taken for the decedent based on the decedent's divisor. Beginning in 2018 the divisor is based on your children's divisors, ie, should be smaller. Unclear which year the $2000 figure given refers to.

UTMAs are taxed based on kiddie tax, too.

No one cares who pays the tax.

It is probably most proper to keep things separately but barring a terrible family breakup in later years it's unlikely anyone will check or care.

[AR]

 I guess it's a stretch in the sense that they will just be taking RMDs for the foreseeable future (as opposed to taking lump sum or 5 yrs).

[AR]

FIREshrink wrote:

IRA distributions are unearned income. Google kiddie tax but they will not owe tax on that amount.

As you know the RMD for 2017 should have been taken for the decedent based on the decedent’s divisor. Beginning in 2018 the divisor is based on your children’s divisors, ie, should be smaller. Unclear which year the $2000 figure given refers to.

UTMAs are taxed based on kiddie tax, too.

No one cares who pays the tax.

It is probably most proper to keep things separately but barring a terrible family breakup in later years it’s unlikely anyone will check or care.

Click to expand...

The $2k is for 2018.

Looks like cutoff for kiddie tax is $2100, so I guess they will be just under for this year.

That solves a lot of the immediate issues.

Now the only thing I need too figure out is if a check is issued in the child's name, can I deposit it in my checking acct or do I need to set one up for them?

 

[jfoxcpacfp]

1. You (they) are just under the limit to owe taxes, so nothing due. Under the IRS matching system, however, I recommend they file a return to report the RMDs.


2. Their rate. The growth (div & CG) will be added to the RMD amount for income tax purposes. Probably still no tax due for a few years, then at 10%


3. You can sign as their guardian and deposit the checks. The main issue is reporting properly.

[AR]

jfoxcpacfp wrote:

1. You (they) are just under the limit to owe taxes, so nothing due. Under the IRS matching system, however, I recommend they file a return to report the RMDs.


2. Their rate. The growth (div & CG) will be added to the RMD amount for income tax purposes. Probably still no tax due for a few years, then at 10%


3. You can sign as their guardian and deposit the checks. The main issue is reporting properly.

Click to expand...

I've got a question about #2. Where did the 10% come from?  I just read something (I think it was on one of the turbo-tax forums) that all unearned income above $2100 will be taxed at my marginal income tax rate.  Is that inaccurate?

[spiritrider]

I would do this in a very transparent way. I would open a UTMA account for both of them and deposit the RMDs directly into those accounts.

Distributions from retirement accounts are considered unearned income and subject to the "Kiddie Tax". There has been unintended misinformation in some of the previous posts. There will be some taxes this year. There are three "Kiddie Tax" tiers

1. While they have no earned income there is an unearned income deduction 2018 = $1,050. This amount will be tax free.
2. The next tier is the same size 2018 = $1,050. This amount will be subject to the dependents ordinary tax bracket (10%). Note: If any amounts in this tier are from qualified distributions or capital gains the tax rate would be 0%.
3. Prior to 2018, the amount > the sum of the first two tiers 2018 = $2,100, was taxed at the parents marginal tax rate. As part of the tax reform, the third tier was changed from the parents marginal tax rate to the trust tax rates. Much was made of the compressed nature of the trust brackets with the top bracket (37%) beginning at $12,500. However, it is actually better for modest unearned income. The tax rate of the first trust bracket $0 - $2,550 is 10%

So the first year with a RMD of $2,000. $1,050 is tax free and $2,000 - $1,050 - $950 * 10% = $95 in taxes. Once the RMD is >= $2,100, the next $2,550 is taxed at the 10% bracket rate. Any amounts in this bracket from qualified dividends or capital gains will be 0%.

So your best investment option for the UTMA accounts would be a TSM index fund. Vanguard would be best because it tends to throw off minimal capital gains and a high percentage of qualified dividends

Another strategy to employ is tax gain harvesting. You should harvest any share price appreciation capital gains up to top of the first trust bracket. The CG tax rate will be 0%. And yes, any tax payments you make will be considered gifts within the annual exclusion.

You could consider opening UTMA 529 accounts for them. Then deposit some or all of the RMDs into the 529s. Such accounts are considered parent assets for FSAFA. This would minimize any "Kiddie Taxes" on the gains UTMA accounts would have received.

[AR]

spiritrider wrote:

I would do this in a very transparent way. I would open a UTMA account for both of them and deposit the RMDs directly into those accounts.

Distributions from retirement accounts are considered unearned income and subject to the “Kiddie Tax”. There has been unintended misinformation in some of the previous posts. There will be some taxes this year. There are three “Kiddie Tax” tiers

1. While they have no earned income there is an unearned income deduction 2018 = $1,050. This amount will be tax free.
2. The next tier is the same size 2018 = $1,050. This amount will be subject to the dependents ordinary tax bracket (10%). Note: If any amounts in this tier are from qualified distributions or capital gains the tax rate would be 0%.
3. Prior to 2018, the amount > the sum of the first two tiers 2018 = $2,100, was taxed at the parents marginal tax rate. As part of the tax reform, the third tier was changed from the parents marginal tax rate to the trust tax rates. Much was made of the compressed nature of the trust brackets with the top bracket (37%) beginning at $12,500. However, it is actually better for modest unearned income. The tax rate of the first trust bracket $0 – $2,550 is 10%

So the first year with a RMD of $2,000. $1,050 is tax free and $2,000 – $1,050 – $950 * 10% = $95 in taxes. Once the RMD is >= $2,100, the next $2,550 is taxed at the 10% bracket rate. Any amounts in this bracket from qualified dividends or capital gains will be 0%.

So your best investment option for the UTMA accounts would be a TSM index fund. Vanguard would be best because it tends to throw off minimal capital gains and a high percentage of qualified dividends

Another strategy to employ is tax gain harvesting. You should harvest any share price appreciation capital gains up to top of the first trust bracket. The CG tax rate will be 0%. And yes, any tax payments you make will be considered gifts within the annual exclusion.

You could consider opening UTMA 529 accounts for them. Then deposit some or all of the RMDs into the 529s. Such accounts are considered parent assets for FSAFA. This would minimize any “Kiddie Taxes” on the gains UTMA accounts would have received.

Click to expand...

Thanks for the response. I thought about putting in their 529s, but both have massive 529s already. So they don't really need any more in there.  Although now that some could be used for grade school I might do that as I could potentially start withdrawing when they're in high school or earlier if the accounts grow a lot.   Of course, it's possible that could be taken away, but I think it's unlikely.

Here's some follow up questions:

1. Let's say I go the 529 route. So it sounds like the cleanest solution would be to set up a UTMA account.  Deposit the RMD into that.  Pay the taxes out of the UTMA account and then send the rest of balance to their 529.  This way the only tax is on the RMD which is taxed at unearned income.

2 If I don't go the 529 route, let's say I open up an UTMA account and just deposit the money there and invest it in a TSM fund.  Then I would need to pay the tax on the RMD, and I think I understand what that is.  But what I don't understand is how I calculate the rates on the dividends and capital gains from the TSM.  It sounds like a lot of it will be zero, but at what point does it go above zero?

Thanks again for the informative reply.

[spiritrider]

Think of the trust brackets sitting on top of the Kiddie Tax dependent rates:

Range: ordinary income tax rate; qualified dividends and capital gains tax rate

• $0 - 1,050: 0%; 0%


• $1,050 - $2,100: 10%; 0%


• $2,100 - $4,650: 10%; 0%


• $4,650 - $4,700: 24%; 0%, *


• $4,700 - $11,250: 24%; 15%


• $11,250 - $14,600: 35%; 15%


• $14,600 - $14,800: 37%: 15%, *


• $14,800+: 40.8%; 23.8%, **

Like for an individual, items subject to ordinary income tax (interest, non-qualified dividends, IRA distributions, etc...) come first then qualified dividends and capital gains.

* don't ask me why, but the 10% trust bracket runs to $2,550 and the 0% capital gains bracket to $2,600 and the 35% trust bracket runs to $12,500 and the 15% capital gains bracket to $12,700. There is the same minor bracket mismatch in the personal brackets.

** I could not find 100% verification, but I think both the 20% capital gains and 3.8% net investment tax begin at $12,700 for trusts.

Despite these weird mismatches, I actually think congress did something right. The original Kiddie Tax rules of using the parents marginal rate was a reaction of parents using UGMA/UTMA accounts as fraudulent tax shelters.

When they really act like mini-trusts. So it only makes sense for UTMA/property guardian taxable/retirement accounts to be treated tax wise as trusts to level the playing field.

 

[AR]

spiritrider wrote:

Think of the trust brackets sitting on top of the Kiddie Tax dependent rates:

Range: ordinary income tax rate; qualified dividends and capital gains tax rate

• $0 – 1,050: 0%; 0%


• $1,050 – $2,100: 10%; 0%


• $2,100 – $4,650: 10%; 0%


• $4,650 – $4,700: 24%; 0%, *


• $4,700 – $11,250: 24%; 15%


• $11,250 – $14,600: 35%; 15%


• $14,600 – $14,800: 37%: 15%, *


• $14,800+: 40.8%; 23.8%, **

Like for an individual, items subject to ordinary income tax (interest, non-qualified dividends, IRA distributions, etc…) come first then qualified dividends and capital gains.

* don’t ask me why, but the 10% trust bracket runs to $2,550 and the 0% capital gains bracket to $2,600 and the 35% trust bracket runs to $12,500 and the 15% capital gains bracket to $12,700. There is the same minor bracket mismatch in the personal brackets.

** I could not find 100% verification, but I think both the 20% capital gains and 3.8% net investment tax begin at $12,700 for trusts.

Despite these weird mismatches, I actually think congress did something right. The original Kiddie Tax rules of using the parents marginal rate was a reaction of parents using UGMA/UTMA accounts as fraudulent tax shelters.

When they really act like mini-trusts. So it only makes sense for UTMA/property guardian taxable/retirement accounts to be treated tax wise as trusts to level the playing field.

 

Click to expand...

Thanks again.  Here are a couple more questions.  How do you know which of the capital gains or dividend rate to apply first?  Here's a contrived example:

Let say the kid has exactly $1051 of income. $551 is RMD and $500 is capital gains.  Is my tax $0 or $0.10?

Also it seems like based on what you are saying capital gains and dividends are treated identically for the purposes of the kiddie tax.  Is that correct?

[spiritrider]

Ordinary income is always applied first then qualified dividends/capital gains. In your example the tax will be $0.

These tax treatments have nothing to do with the Kiddie Tax. The Kiddie Tax only specifies the tax brackets.

Interest, non-qualified dividends, taxable retirement plan distributions, earned income, etc... are subject to the applicable ordinary income tax rates.

Capital gains and qualified dividends are subject to the applicable capital gains tax rates.

 

[AR]

Thanks again.  I appreciate the help.