Tax implications on income of a minor – What every parent should know

• When considering the income of minors, distinguish between two forms of income - earned and unearned.
• Earned income isn’t clubbed with the parent’s income.
• Unearned income offers certain deductions to the parent.
  

12-year old Mayank has become the youngest child to win ₹1 crore at the ‘Kaun Banega Crorepati 15’ in its ‘KBC Juniors Week.’ When talented kids like Mayank win prize money in contests and shows, how is the income taxed? Also, how is other income of a child taxed? We take a look.

How the income of a minor is taxed

Income earned by a minor child from activities involving their skills, talent, or specialised knowledge, such as winnings from contests like KBC, is generally subject to taxation.

“According to section 115BB of the Act, minors are required to pay tax on this income at a flat rate of 30% on a gross basis. Additionally, there's a health and education cess of 4 % on the basic tax liability,” says Abhishek Soni, CEO, Tax2Win.in, a tax filing platform.

The entity that disbursed this income would have already deducted tax from the prize money at a flat rate of 30%, plus health and education cess of 4%. Importantly, no tax deduction or exemption is allowed against this type of income for minors.

Distinguishing between ‘earned’ and ‘unearned’ income

When considering the income of minors, it is important to distinguish between two forms of income - earned and unearned income.

Earned income: If the child earns income through prizes in competitions, shows, sports, or engages in personal business must be treated as earned income.

“Basically, earned income refers to the money a minor earns through manual work or by applying their skills, talents, specialised knowledge, or experience. Earned income will not be clubbed with parent’s income. It will be taxed in the hands of the minor,” says Archit Gupta, Founder and CEO, Clear, a fintech company.

Unearned income: Under the Income Tax Act, if a minor receives funds as gifts or earns interest through savings, fixed deposits, or investments made in their name by parents, relatives, or friends, it's categorised as unearned income. This includes interest accrued from savings accounts or investments in the minor's name facilitated by parents.

“According to section 64(1A) of the Act, any such income received by a minor is included in the parent's income, known as "clubbing of income”, says Soni.

Here, there can be two scenarios.

Minor's income up to ₹1,500/-year: If the minor's annual income remains within ₹1,500, it won't be added to the parent's income. Section 10(32) allows for tax exemption on income up to ₹1,500 per child, with a maximum of two minor children. This exempted income can include amounts transferred by parents, grandparents, or any other person.

Minor's income exceeding ₹1,500/year: If the minor's income exceeds ₹1,500 annually, it will be clubbed with the higher-earning parent's income for tax purposes. However, a tax exemption of ₹1,500 per child per year, up to a maximum of two children, is available to parents. This exemption is claimed under section 10(32) of the Income Tax Act.

However, the parent claiming this deduction on the minor's clubbed income must opt for the old tax regime; it's not applicable in the new tax regime.

Tax implications when income of a minor is invested

Parents can invest in bank fixed deposits (FDs) or various post office schemes in the name of their minor child. When it comes to investing in mutual funds or equities in the name of a minor there is no restriction.

However, this process usually requires offline procedures, including physical documentation. “Parents cannot make these investments online on behalf of their children. For investing in equities, a parent can open a demat account specifically in the name of the minor. This account allows for the purchase and holding of shares in the minor's name,” say Soni.

Income from any such investment falls under the category of unearned income and is hence taxed in the way mentioned above.

Does a child need to file income tax returns?

A minor can have a PAN card. The parents or guardian can apply for a PAN card on behalf of the minor child. “If the minor child’s tax returns are being filed independently, he will need to have a PAN card along with other details like bank account, mobile number, e-mail ID etc,” says Gupta.

So, if a minor generates income from sources like winnings in competitions, performances, sports, or through personal business, self-employment, or part-time work, it qualifies as earned income. This income remains separate from the parent's or guardian's earnings. The minor must file an income tax Return (ITR) and must obtain a PAN card for this purpose.