Why did farmers use to have lots of children? – taxing children as adults

 Division 6AA of Part III of the Income Tax Assessment Act 1936 (Cwth) (‘the Tax Act’) was introduced in 1980. Up until then each of your children under 18 years of age were treated as adults for tax purposes. Twelve children meant that in a Testamentary Trust or Family Trust you could equally split the income 14 ways – including mum and dad. Big families paid little tax.

 Before Division 6AA Family Trusts were conducted on the basis that children as young as 6 months old received a full share of income along with other family members.

 At that time children paid income tax according to the normal rates payable by an adult. Therefore, the family could take advantage of the different marginal rates and the tax free threshold for each family member.

 The introduction of Division 6AA marked the death knell of this income splitting practice.

 Division 6AA does have exceptions. Some children can still get the adult tax rate.

 However, if a child under 18 years does not fall within one of the exceptions outlined in Division 6AA, then a penal rate of tax applies to any income derived by that child above $416 (or $643 if the minor is eligible for a rebate as a low income taxpayer).

 Section 102AG is the child’s friend. It defines ‘excepted trust income’. This is income falling within one of the exceptions in Division 6AA so that the normal adult marginal rates apply to income derived by a person from the relevant trust.

 Which is the provision for dead people and the 3 Generation Testamentary Trust? It is section 102AG(2)(a) which provides:

 ‘Subject to this Section an amount included in the assessable income of a trust estate is excepted trust income in relation to a beneficiary of the trust estate to the extent to which the amount:

 (a) is assessable income of a trust estate that resulted from:

 (i) a Will, Codicil or order of a court that varied or modified the provisions of a Will or Codicil; or

 (ii) an intestacy or an order of a court that varied or modified the application, in relation to the estate of a deceased person, of the provisions of the law relating to the distribution of estates of persons who die intestate.’

 What does that mean? The punishing effect of Division 6AA does not apply to the 3 Generation Testamentary Trusts if the child under 18 years of age receives income from a trust set up in a Will. Therefore, the more liberal adult marginal rates of tax apply to that lucky child. The child does not have to be a child of the deceased. The child can be any beneficiary named in the 3 Generation Testamentary Trust. This includes a grandchild, mistress, nephew or distant relative.

 Assume the wife dies. The husband controls the 3 Generation Testamentary Trust Will. He has 3 children aged: 6 months, 3 years and 7 years.

 The wife left, say, $2m. Her estate returns an income of $200,000 per year. The husband has no other income as he has to stay at home to look after his children. The tax rate of 48.5% would have of applied to most of that income if the dad was left to shoulder the tax burden all by himself. The tax payable is $82,620.

 But with the 3 Generation Testamentary Trust all 4 of them (including the 6 month old baby still in her cot) got an income of $50,000 each for the 04/05 financial year. Their individual amounts of tax payable are $11,831. Times that by 4 and you get an overall tax burden of only $47,324. That is a saving of $35,296.

 Also see: Income of minors http://www.ato.gov.au/individuals/content.asp?doc=/content/20046.htm&pc=001/002/046/002/018&mnu=1045&mfp=001/002&st=&cy=1

What rate of tax applies to income of minors? http://www.ato.gov.au/individuals/content.asp?doc=/content/20046.htm&page=6&H6=&pc=001/002/046/002/018&mnu=1045&mfp=001/002&st=&cy=1