Deconstructing a tax law change: The case of the kiddie tax.

• Author: Nellen, Annette

The Tax Cuts and Jobs Act (TCJA), P.L. 115-97, created many new challenges for both practice and education. Faculty are confronted not only with needing to be proficient with a new piece of legislation but also with developing effective means for helping students to understand the material. New law, however, creates an opportunity for the classroom: Professors can model for students how to deconstruct a change. This can reveal to students the various processes to understand not only the provision being examined currently but also other provisions they will encounter throughout the semester. In doing so, they gain the skills and abilities to be able to confidently embrace change throughout their careers.

The benefits of modeling a tax provision

Students need help understanding how to deal with the complexities of the tax law. They have been rewarded for memorization throughout their academic careers. When attempting to apply this practice in a tax course, students can become overwhelmed quickly by detail. They want to default to templates and worksheets rather than developing their own understanding. They also fail to understand that tax software, although extremely useful, is often flawed and its output needs verification. Students do not yet comprehend that, once they leave campus, they will need to be able to explain outcomes both within the firm and to clients, subsequently teach new hires, and eventually review and correct the work of others. Thus, faculty must assist students in creating techniques to manage detail and build comprehension.

A technique to help students understand the technical aspect of rules is to encourage them to take a scientific approach--build a model, then repeatedly test it to make sure it works. The schema can take one of several forms--decision tree, flowchart, or summary--depending on the topic and the student's learning style. Experimentation with different approaches should be encouraged. The focus should be on decision rules and how to identify key data triggers that suggest action. Once a model is in place, it should be applied to many scenarios to ensure viability.

This approach has three benefits. First, students should develop the confidence that they have a plan of attack for whatever might be asked on an exam. Second, students begin to see mistakes less as failures and more as opportunities to refine the model that they are conceiving. Third, and most importantly, students develop an understanding that transcends templates and worksheets, and create processes that allow them to check the accuracy of software outcomes.

Deconstructing the kiddie tax calculation into decision rules

As an example for modeling a difficult tax provision, consider the kiddie tax calculation, a topic the author chose to address early in the semester for three reasons. First, the semester begins by exposing students to key tax concepts, and the kiddie tax provides an interesting application of the assignment-of-income doctrine. Second, the kiddie tax can reinforce early learning of the tax equation, the use of rate schedules, and the use of preference rates. Third, the kiddie tax provision is an excellent starting point for learning to work with the Code, including the need to cross-reference other sections.

Historically, the kiddie tax calculation used the parents' marginal tax rates. Because the kiddie tax was designed to be a penalty, Sec. 1(g)(1) required the tax to be the greater of the tax computed on the child's taxable income using the single rates or the tax computed on the net unearned income using the parents' rates, plus the tax on the remaining income using the single tax rates. Although theoretically consistent with the concept that the unearned income is derived from assets shifted to the child by the parents, the computation of the tax on the net unearned income was unduly complex in two common cases. First, when the parents filed separate returns, Sec. 1(g)(5) required the use of the tax rates of the custodial parent when the parents were not married, or the tax rates of the parent with the higher taxable income when the parents were married but filing separately. Second, when the child had siblings, Sec. 1(g)(3)(B) required that the parents' rates be prorated across all the returns of the children subject to the kiddie tax.

In determining the tax on the net unearned income, the TCJA attempts to simplify the calculation by replacing the use of the parents' rates with the rates used to tax trust income. Sec. 1(j)(4)...