Children can earn income from various sources, such as savings accounts, part-time jobs, or even small business ventures. Similar to adults, children have their own tax allowances. However, specific rules prevent parents from using their children’s tax-free allowances to reduce their own tax liability. This blog post explores the intricacies of child income taxation and when it might impact parents.

Earned Income

When it comes to income earned by children through work, the tax rules are largely the same as those applied to adults. Each child has their own personal allowance, which means they can earn up to this amount without paying any tax. For the 2024/25 tax year, this allowance stands at £12,570. Additionally, children benefit from the £1,000 trading allowance if they have income from small business activities, such as selling items online.

It’s worth noting that children under the age of 16 are not required to pay National Insurance contributions, which sets them apart from adult workers. This can be particularly relevant for teenagers with part-time jobs or those engaged in freelance work.

Savings Income

In most cases, children only need to pay tax on their savings income if it’s substantial. They can shelter their savings income from tax by using their personal allowance, the personal savings allowance, and potentially the savings starting rate band.

However, there’s a crucial exception to this rule that parents need to be aware of. If a child receives interest of more than £100 per year on money given to them by a parent, the situation changes dramatically. In this case, the entire interest amount is treated as the parent’s income for tax purposes, not the child’s.

To put this into perspective, with an interest rate of 5%, this rule would apply if a parent had given their child £2,000 or more. It’s important to monitor interest rates, as rising rates could push previously compliant arrangements over the £100 threshold, triggering these anti-avoidance rules.

Importantly, this rule only applies to money given by parents. Gifts from grandparents, other relatives, or friends are not subject to this restriction, and any income generated from these gifts is taxed as the child’s own income, regardless of the amount.

Practical Examples

1. Sarah, aged 10, receives £10,000 from her mother, who has recently inherited some money. The account earns 5% interest annually, generating £500. Because this exceeds the £100 threshold, the entire £500 is treated as Sarah’s mother’s income for tax purposes. If the mother has already used up her personal and savings allowances, she’ll pay tax on this amount at her marginal rate.
2. Jack, also 10, receives £10,000 from his grandmother who has downsized her home. His account also earns 5% interest, generating £500 annually. In Jack’s case, this £500 is treated as his own income. It’s likely to be tax-free as it falls within his personal savings allowance.

Avoiding the Parent-Gift Tax Trap

One way to navigate around this tax issue for parental gifts is to consider a Junior ISA (Individual Savings Account). Parents or guardians with parental responsibility can open a Junior ISA, but the money in the account legally belongs to the child. There are two types available: cash ISAs and stocks and shares ISAs. A child can have one of each type.

For the 2024/25 tax year, the Junior ISA allowance is set at £9,000. This limit applies across both types of accounts combined, not per account. Junior ISAs have the significant advantage that all income earned within them is tax-free. This includes interest on cash ISAs and dividends on stocks and shares ISAs.

Key Takeaways

• Children have their tax allowances, including personal and trading allowances.
• Income from work is generally taxed the same for children as for adults, but children under 16 don’t pay National Insurance.
• Savings income given by parents that generate more than £100 interest annually is taxed as the parent’s income.
• Gifts from non-parents (grandparents, other relatives, friends) don’t fall under this rule.
• Junior ISAs offer a tax-efficient way for parents to save or invest for their children.

Understanding these rules can help families make informed decisions about managing their children’s income and savings. As with all tax matters, if you need clarification on your specific situation, it’s always best to consult our qualified tax professional for personalised advice.