What tax is payable on children’s investment income (minors)?
The tax rates payable by individuals, resident of Australia, on income earned from all sources are set out in Tables on this page on the ATO website. The effect is that no tax is payable on taxable income until it is clearly in excess of $20,000 (as at June 2021). Children’s investment income is caught under specific taxing rules.
Where the individual is under 18 years of age and not subject to exceptions mentioned further below, the rates are as follows (and Medicare levy may also need to be added) –
- up to $416: nil tax payable;
- between $417 and $1307: the rate of tax is 66%; and
- over $1307, the rate is 45%.
Note: Tax rates are revised periodically, but the rates for children’s investment income have remained the same (other than with the variation to the Medicare Levy, up from 1.50% to 2.00%) for at least a decade now (June 2021 revision). To stay up to date with the rates applicable to children’s investment income – and other unearned income – refer to this ATO website page and to links from it. (Be aware that this ATO website page is occasionally taken down to be refreshed: this is usually a temporary situation.)
How does the special tax rate on children’s investment income (indeed any unearned income), work?
Children under 18 years (‘minors’) are subject to particular tax rules on their investment income. These rules were introduced to discourage people from investing in children’s names and accessing the lower marginal tax rates multiple times. The special tax rules apply to what is called ‘unearned income’. This generally includes bank interest, share dividends and distributions from trusts where the asset is not legitimately owned by the child (together, referable as children’s investment income). An example of this would be where a parent establishes a $50,000 share portfolio in a child’s name. Where the minor receives both excepted income and eligible taxable income the calculation is subject to other special rules.
Note: Until 2013 financial year, minors were also entitled to the ‘low income’ tax rebate of $1,200, meaning they could effectively have received $1,667 tax-free. This no longer applies.
Does the special tax rate apply to the investment income of all children (minors)?
Some children under 18 years of age are not subject to the special tax rules. They enjoy the same tax treatment as adults.
The children exempted from paying the penal rates of tax are those who are:
- Permanently disabled, or
- In receipt of a child disability allowance, disability support pension or double orphan pension.
Does the special rate of tax apply to all income earned by a minor?
Some specific children’s investment income (and other-sourced income) is excluded from the special tax rules. This is called ‘excepted income’ and includes income from:
- The investment of property arising from the death of another person, including testamentary trusts,
- Damages awards,
- Divorce decrees or orders, and
- Gambling wins.
Excepted income enjoys the same tax-free threshold as applies to adults.
What can be done to minimise the special rate of tax on children’s investment income?
Below are some of the strategies that you should consider to minimise the effect of the penalty tax rates:
- Ensure that any investments in your children’s names do not generate more income than $416.
- Consider growth investments which produce little taxable income, but high capital growth.
- Invest in a product where the tax is paid for you, or is deferred until the product matures. For example, an insurance bond or endowment warrant, that will pay tax on the earnings each year and, after 10 years, the earnings will be “tax free” (really tax-paid) in your hands, so these can be quite tax-effective options for those paying a higher marginal tax rate.
If, for example, the warrant is purchased when the child is eight years old, when he or she turns 18 there is the option to:
- exercise the warrants and receive the shares. As the child is no longer considered a minor, the dividend income they start receiving will be taxed at adult tax rates. Many will be receiving low income for several years and therefore subject to little or no tax on dividends, or
- sell the warrants and use the funds to further their career and education.
Special education plans are another option. These are simply life insurance endowment policies and receive a similar tax treatment to insurance bonds. Most are structured to mature when a child reaches a certain age, such as 18, rather than having a 10-year life.
Consider incorporating a testamentary trust in your Will if you want to pass income through your estate to young children and grandchildren. If the child is a beneficiary of a testamentary trust, their benefit is taxed as though they are an adult. This means that the adult tax-free threshold of $18,200 applies, as do the progressive marginal tax rates.
A family discretionary trust may be useful in distributing investment income in a tax-efficient manner. In this way, a small amount of income can still be distributed to children tax free, and the remainder distributed to adults.
Whilst penalty tax rates have deterred the common practice of simply placing an investment in a child’s name, with careful planning astute parents can still uncover an array of favourable investment opportunities.
Seeking advice on securing your child’s financial future?
Continuum Financial Planners Pty Ltd provides a holistic approach to financial planning embracing wealth accumulation and protection strategies: ‘we listen, we understand; and we have solutions’ to investment dilemmas such as the special rates of tax applicable to children’s investment income – and we can deliver those solutions to you in personalised, professional wealth management advice. To arrange a meeting with one of our experienced advisers, call our office (on 07-34213456), or use the Contact Us facility on our website.
Originally posted in October 2012, this article has occasionally been refreshed/ updated, most recently in June 2021