Why teen was taxed over birthday gift and pocket money savings

A 15-year-old schoolboy who saved his hard-earned KFC wages and birthday money to buy his first car has been hit with a surprise tax bill, leading his forensic accountant* dad to call out a little-known tax rule.

The teenager earned $6,200 working casually at the fast-food chain over the financial year*. While he had recently started depositing his pay cheques into his savings account, much of his bank balance, and the roughly $500 in interest* it generated, came from years of birthday presents and cash gifts he had banked.

When it came time to lodge his very first tax return, he expected a modest $16 refund* for tax withheld by his bank. Instead, he was shocked to find he was liable to pay more than $50 of tax.

“He was sitting there expecting his $16 back to buy us some KFC,” his dad, Trevor Monaghan, told news.com.au.

The teen’s brother, who earned much more through wages but had earned minimal bank interest, received a tax refund.

It’s understood the teen likely had around $9,000 in savings in his bank account, based on a typical interest rate of 5 per cent.

THE 43-YEAR-OLD RULE CATCHING OUT TEEN SAVERS
Australian tax law does not penalise teenagers for saving their working wages. Any bank interest earned directly from deposited pay packets aren’t taxed at penalty rates*.

However, the interest generated by the teen’s non-wage savings, being his accumulated birthday gifts, was taxed at a high rate because of a little-known tax law introduced four decades ago.

Under Australian tax law, once a person under 18 earns more than $416 in passive income (which is income not earned through working, such as bank interest or dividends*), they are hit with penalty tax rates starting at 66 per cent until it levels out at the top marginal rate* of 45 per cent.

The legislation was introduced 43 years ago to prevent wealthy parents from depositing money into their children’s bank accounts to avoid paying tax themselves.

However, the $416 threshold has never been indexed* for inflation*.

Since the value of money decreases over time, wages increase and things get more expensive, $416 in 1983 would be worth much more now. So while it doesn’t take much to get to $416 today, that amount would have equated to a lot of money four decades ago when the law was brought in.

In fact, if the threshold had kept pace with inflation since its creation, its value would sit at over $1350 today, meaning thousands of teenagers saving for their first cars, computers, or university funds would pay $0 in tax.

“He’s learning that you have to work within the system you’re given and that life isn’t always fair,” Mr Monaghan said. “It’s not even about the $50. It’s the disappointment on his face. He’s asking why the government wants his money when he’s just trying to save.”

Mr Monaghan said that while the small portion of interest generated by his son’s KFC wages is legally exempt* from the $416 threshold, separating that exempt wage interest from the non-wage interest would be a very complicated practice.

Separating exempt wage interest from non-exempt gift interest in a combined account would require a forensic* daily tracking calculation. An accountant would need to review daily bank balance changes over the entire year to attribute exact interest percentages to wage deposits versus pocket money.

Completing that level of forensic work would cost between $200 and $300 in professional accounting fees, making it completely pointless to spend hundreds of dollars just to wipe out a $50 tax bill.

“As a busy forensic accountant and his dad, I could explain how it happened, but not why the system works this way,” Mr Monaghan said.

“We have a system where you need to hire an accountant to help you avoid paying tax on money you legally shouldn’t be taxed on in the first place. He doesn’t have the skills to do the daily spreadsheet, I don’t have the time, so in the end, we just pay the tax.”

BRACKET CREEP PENALISING REGULAR AUSSIES
Mr Monaghan said his son’s experience is just one example of a greater problem: the refusal of successive governments to index tax thresholds to inflation.

He said unindexed tax limits on income tax brackets act as a silent, ongoing tax hike on everyday Australians. As wages rise to keep up with inflation, workers are pushed into higher tax brackets without actually gaining any real purchasing power*.

“If you look right across the board, thresholds haven’t kept pace,” Mr Monaghan said. “Bracket creep* is dragging lower- and middle-income earners into penalty tax brackets. It is a passive revenue grab* that makes everything more expensive without delivering any actual productivity*.”

He said the lack of indexation and increasing tax complexity hit younger generations the most when they were already struggling to ever buy homes or build wealth.

“This young generation coming through, how do they catch up?” Mr Monaghan asked. “If you don’t own a house and don’t have wealthy parents, what mechanisms are there in the tax system for you to build wealth? Everything feels stacked against them. We talk about closing the wealth gap, but the system penalises young people trying to get ahead on their own initiative instead of encouraging financial independence.”

POLL

GLOSSARY

• forensic accountant: a financial expert that analyses financial records to uncover fraud and trace hidden money in legal proceedings
• financial year: the financial year runs from July 1 to June 30 each year. When you lodge your tax return, it is based on how much you have earned during the financial year
• interest: extra money a bank pays you for keeping your money deposited with them. If your savings account has an interest rate of 4 per cent, for example, you earn 4 per cent of the balance
• refund: a tax refund is an amount you get back after you lodge your tax refund if the Australian Taxation Office (ATO) finds that the tax deducted from your pay throughout the year was higher than the amount you were actually liable to pay based on your income
• penalty rates: higher rates of tax than usual
• dividends: a portion of a company’s profit paid out to shareholders
• marginal rate: the percentage of tax you pay on each dollar you earn. Under the current tax rates in Australia, you pay zero tax on the first $18,200 you earn, then 15c for each $1 over $18,200 or $4,020 plus 30c for each $1 over $45,000 or $31,020 plus 37c for each $1 over $135,000 or $51,370 plus 45c for each $1 over $190,000
• indexed: pegged to the rising cost of living to protect purchasing power
• inflation: the general rise in the cost of goods and services over time, caused by factors such as greater demand that supply, an increase in the cost of raw materials and an increase in the amount of money circulating through the economy, causing money to lose value
• exempt: free from a rule that usually applies
• forensic: a forensic daily tracking calculation is a detailed accounting method that helps to identify financial patterns
• purchasing power: the amount of goods and services that money can buy at any given time, showing the real world value of currency
• Bracket creep: where inflation pushes people into higher income brackets even though their purchasing power hasn’t increased
• revenue grab: when the government tries to collect as much money from taxpayers as possible
• productivity: how efficiently resources, such as labour, time and materials, are turned into goods and services

EXTRA READING
Budget ends 27-year-old tax rule
Why petrol prices are soaring
All aboard RBA runaway rate train

QUICK QUIZ
1. What was it about the 15 year-old’s bank balance that led to him having a tax debt of $50?
2. In what way does the law that sees minors get taxed at penalty rates for non-working income above $416 help to prevent parents from stashing their own money in their kids’ accounts?
3. Why was it pointless for the 15 year-old to pay for an accountant to reduce the amount of tax he owed?
4. How has inflation affected the purchasing power of workers even if their wages have gone up over time?
5. Which generation is hit the hardest by the lack of inflation indexation in the tax system?

LISTEN TO THIS STORY

CLASSROOM ACTIVITIES
1. Bank interest True or False quiz
Work with a partner to read the following statements and agree upon whether they are true or false. If you disagree, ask another pair of students.

• A bank can pay you interest for keeping money in an account? T/F
• 5 per cent of $100 is $50? T/F
• The more money you save, the more interest you can earn at the same rate? T/F
• An interest rate of 10 per cent is higher than 5 per cent? T/F
• Interest can be calculated as a percentage of your savings? T/F
• If you earn interest, your balance can increase? T/F
• A higher interest rate always means you earn more money? T/F
• Interest rates can change T/F

Summarise how interest can help you save?

Time: allow 15 minutes to complete this activity
Curriculum Links: English, Mathematics, Personal and Social, Critical and Creative Thinking

2. Extension
Inflation is the general increase in the prices of goods and services over time, which means your money buys you less than it used to.

Why does $50 today buy less than $50 several decades ago?

Time: allow 10 minutes to complete this activity
Curriculum Links: English, Mathematics, Personal and Social, Critical and Creative Thinking

VCOP ACTIVITY
BAB it!
Show you have read and understood the article by writing three sentences using the connectives “because’’, “and”, and “but” (BAB). Your sentences can share different facts or opinions, or the same ones but written about in different ways.