There has been a lot of discussion about how the SECURE Act affected retirement accounts. What hasn't received a lot of press is a change to tax law on how children are taxed on unearned income. And this change could result in significant tax savings for children of deceased military members or retirees who receive SBP.
The Tax Cuts and Jobs Act (TCJA) changed the tax treatment of children's unearned income. Under the TCJA the unearned income is tax as if it was earned by a trust. Under the old law, the income was taxed at the parents' rate. I should note that the first $2,000 or so (depending on which year we're talking about) wasn't subject to the tax.
Trust tax brackets are very flat and at approximately $12,700 of income (again depending on the year) eaned by trusts are taxed at the highest rate of 37%. And therein lies the rub.
SBP payments to children are considered unearned income for tax purposes. It is quite likely that a child could receive well in excess of $12,700 of SBP pay-outs in a year. All the income above that threshold will be taxed at 37%. And let's face it, there are that many parents, especially widow(er)s that are in the 37% tax bracket. This was a big tax increase on families that really couldn't afford it.
There is Some Good News
As mentioned the SECURE Act changed the rules, so now the unearned income is taxed at the parent's rate. That is good news. What is really good news, is that the SECURE Act applies retroactively to 2018. So if the TCJA rules hurt you or someone you know, they have the right to file an amended return for 2018 and apply the rules to their 2019 tax return. Sometimes Congress does thing right.
Military Finances are Different
Just like a military career isn't exactly like a civilian career, military finances, especially when concerning taxes, aren't like civilian finances. If you're going to work with a financial planner, we think you should work with one that deals with the ins and outs of military finances each and every day.
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