Marriage provides the opportunity to income split. Having children puts you in a position to cut down the tax bill even further. Understanding these rules and seeking professional advice is important prior to implementing any income splitting strategy. The following outlines some income splitting strategies with your children.
Employ your children
This strategy is applicable to those individuals who own a business. Wages paid to your spouse and children may be a deductible expense for your business provided services are performed. Your spouse or children would include the wages earned as employment income. This strategy moves income from the higher-income spouse operating the business, who is in a higher tax bracket, to the spouse or child who is in a lower tax bracket.
A parent can purchase investments that create capital gains in a child’s name. Non-dividend paying common shares and growth mutual funds are two examples of investments, which may generate a capital gain. All capital gains are specifically exempted from the attribution rules with respect to property transferred to a minor. Any resulting gains are not attributed back to the parent. Income attribution rules will apply on any interest and/or dividend income earned. At age 18 the investment becomes the property of the child.
Child Turning 17
Some parents may consider giving their children funds to invest. If a child turns 17 in the year the gift is received then the funds may be invested in a term deposit or GIC with a maturity of one year or greater. The interest payment will be made in the year the child turns 18 and no attribution will result. This strategy may coincide nicely with covering the costs of post secondary education.
As noted above, the attribution rules do not apply to capital gains. If a parent has a corporation and they expect the shares of the corporation to increase in value then we recommend that you seek the advice of a tax expert. In some cases the use of a trust may be necessary. As an example, let’s use a parent with shares in a private business that were purchased for $10,000 but are now worth $100,000. If the shares are given to children then a deemed disposition will likely have occurred. Any resulting capital gain may be offset by the lifetime capital gain exemption (2007 Federal Budget proposes to increase the lifetime capital gains exemption to $750,000 from $500,000 for capital gains realized on the sale of qualifying small business shares and qualifying farm or fishing property). In future years the children can sell these same shares and also take advantage of the capital gains exemption. Proper professional advice should be obtained prior to any transfers to children.
In addition to shares of a private business, parents may want to consider transferring other assets that may generate a capital gain. Examples may include shares in speculative publicly traded companies, artwork, and jewelry. Proper professional advice should be obtained prior to any transfers to children.
Baby-sitting wages paid to your lower-income adult children or lower-income adult family member (i.e. grandparent) can be claimed as childcare expenses. The adult children will need to provide the higher-income parent with a receipt and subsequently claim any income. This allows the higher-income parent(s) to deduct these expenses to offset employment or business income.
Child Tax Benefit
The child tax benefit cheque can be deposited in a bank account in the child’s name. Income earned on those funds is not subject to attribution to the parent.
Universal Child Tax Benefit
The universal child tax benefit cheque can be deposited into a bank account in the child’s name. Income earned on those funds is not subject to attribution to the parent.
Registered Education Savings Plan
The perfect income splitting tool relating to parents and children is the Registered Education Savings Plan (RESP). Although parents that contribute to an RESP do not receive a deduction, they are shifting funds to a tax-deferred vehicle. In addition to the deferral, the child may be eligible for Canada Education Savings Grant. When the income and grant component (not the original capital contributions) are pulled out of the RESP it is taxable income for the child. The latest Federal Budget provided some positive changes with respect to RESPs. A column this summer will be dedicated to providing an update with respect to these changes.
Many children work over the summer months and use those earnings to fund university or other expenses. The child could invest the $8,000 that they made over the summer. The higher-income earning parent could pay for the child’s tuition and basic expenses. If parental assistance is not an option then consider an interest free loan. After university is completed then the principal amount of the loan can be paid back with the funds the child invested.
In many cases the above strategies result in your child obtaining control of the respective asset. This is a very important factor for parents to consider. Saving taxes through income splitting may also be the ideal opportunity to teach your children financial responsibility.
Prior to implementing any income splitting strategy we recommend individuals meet with their professional advisors.