Children may seem to get the short stick of tax law when it comes to taxation. Children under the age of 18 years can only earn $416 in a year before they pay the top rate of tax (47%) on their income.
For example, if a 15-year-old earns $2,000 in interest for the year, they will pay close to $1,000 in tax on those earnings. The reason for such a high tax price is to prevent people from investing money in their children’s names so that they won’t pay any tax on the earnings.
This may not seem fair though, as children may earn money from investments that haven’t been put there to benefit someone else with tax savings. One such example is the money that may have been received in a will.
The tax law provides a few exemptions to the rule that taxes minors at the top rate of 47%. One such exemption is for earning from assets left to them in a will or earning from distributions from a trust established under a will. A trust that is established under a will is known as a testamentary trust.
If a child earns $2,000 in interest from money left to them under a will, the special rules for minors would not subject them to the 47% rate of tax. Instead, as those earnings came from money left to them in a will, they would simply pay the normal adult rates of tax on the interest. If this was their only income, they would be well below the tax-free threshold and would not pay any tax on the earnings.
There are a lot of rules around what can be done with investments, which is why starting a conversation with us if your child is to receive an inheritance is a step in the right direction. If you are thinking about leaving assets to a child or grandchild in your will, we can also assist you with tax planning for this eventuality.
Lawyers may be the key to drafting strong and valid wills, but there are great tax-planning opportunities for nearly everyone when it comes to planning for your estate.