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Taxing times for children under 18 – should they save or should they spend?

Friday, May 27, 2011 - 16:42 | Posted By: The Privately Held Business Team
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Families need to urgently assess the impact of the 10 May Federal Budget announcement to restrict the access by minors to the low income tax offset (LITO) for the 2011-12 income year onwards.  On 26 May 2011, the detail of this measure emerged when Tax Laws Amendment (2011 Measures No 4) Bill 2011 was introduced into Parliament with the claim that "the low income tax offset was never meant to act as a tax minimisation vehicle".  Some actions may be required by 30 June 2011 to limit the long-term impact of this measure.

From 1 July 2011, the removal of LITO for minors on their unearned income effectively reduces their tax-free threshold on unearned income by 87.5% from $3,333 to $416. If the income is franked, the reduction is even more stark: 92.4% from $7,000 to $534!

The availability of LITO to minors was perceived to be a "loop hole" available to wealthy Australians to divert or split income tax-free to their children.  The measure is predicted to raise $250m each year. This includes potentially raising tax from children who have invested their cash gifts rather than spending them.

Since 1980, minors have been taxed at the prevailing top marginal rate on passive or unearned income pursuant to Div 6AA of the Income Tax Assessment Act 1936.  This would include dividends, interest, rent and family trust distributions.  Prior to this, family groups could have all members of the family, including minors, take advantage of graduated tax scales.

Initially, a Div 6AA threshold of $1,040 applied which reduced to $416 from 1 July 1983.  However, from 1 July 1993, a low income tax rebate of $150 applied to effectively boost this threshold to $643.  Since 2003, the rebate (or its successor LITO) has progressively increased enabling more income to be split to the minor tax effectively.

Now, on the precise date that this rebate/offset turns 18, it is to be consigned to history for most minors.

Who is affected?
The proposed changes to LITO affect income derived by minors from 1 July 2011 onwards to the extent that their income is already subject to Div 6AA.  Division 6AA broadly applies to all persons under 18 years of age (called "prescribed persons") unless they are "excepted persons" or to the extent their income is "excepted assessable income".

An "excepted person", who is not impacted by Div 6AA at all and thus will not be affected by these changes, includes:

  • Minors in full-time employment.
  • Minors with certified disabilities, including where certain specified allowances or pensions are provided.
  • Minors who are double orphans.

For minors not in such categories, certain "excepted assessable income" will also continue to benefit from the offset. This includes:

  • salary and wage or business income;
  • income from a deceased estate;
  • income earned on assets devolving from a deceased estate to the minor;
  • superannuation income streams that are death benefits;
  • income derived from investment of other excepted assessable income.

Practically, these changes will have most impact on people who are not using LITO as a tax minimisation vehicle. Minors that have had money genuinely set aside for them will only be able to accumulate around $6,900 of investment funds before they commence to pay tax on the income generated assuming a 6% per annum return.

These changes will result in an additional tax burden to a family group in 2012 of $1,356 per minor or $2,355 if income is fully franked (excluding flood levy and assuming the income will be taxed at the top marginal rate). 

The table below tracks the level of this benefit since 2005-06:

  LITO Tax-Free Income Tax-Free Fully Franked Income
2006 235 772 990
2007 600 1,333 2,800
2008 750 1,667 3,500
2009 1,200 2,667 5,600
2010 1,350 3,000 6,300
2011 1,500 3,333 7,000
2012 0 416 534

Where to from here?
Families should assess whether any minors are in fact “excepted persons”. This is something that needs to be assessed as at each year end.
Trustees of discretionary trusts should consider changing their distribution patterns from 1 July 2011 and inform affected stakeholders. This should be easy to achieve, but be wary of the impact of the change in distribution pattern on important tax concessions like the CGT small business relief.

Don’t throw the baby out with the bath water!  Of course it still may be effective overall to distribute to minors to give effect to succession, estate and wealth planning, especially if other potential unaffected beneficiaries are already at the top marginal tax threshold.

Where minors are generating investment income in their own names, whether directly or indirectly via some type of fixed trust:

  • investigate whether the income is "excepted assessable income". For example, earnings from investments that accumulated from the minor's personal earnings will be excepted assessable income;
  • consider re-arranging investments so that they do not create as much assessable income. For instance, disposing of assets in the 2010-11 year, when LITO is still available, may limit any capital gains tax.  Any new investments could be then focused on capital growth which may not be realised until after the minor has turned 18.

The Government should also re-consider the size of the Div 6AA threshold. $416 in 1983 terms is hardly worth any more than a round of drinks in 2011 terms. Surely imposing a level of around $1,000 would make more sense and still give effect to the overall objective. This would also prevent tax in many cases where this measure will have an unintended impact, including where children have chosen to save cash gifts rather than spend them.

This article is general in nature and its brevity could lead to misrepresentation. The information contained in this blog is not intended to be advice and could be subject to change. No responsibility can be accepted for those who act on its contents without obtaining specific advice from an advisor.


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