I’m encouraging my kids to read. My youngest wants to read the Diary of a Wimpy Kid series. It’s not exactly The Diary of a Young Girl by Anne Frank, but it’s better than nothing. My daughter has decided she’s going to read The Globe and Mail this summer. “Dad, your articles are kind of boring,” she said. “Except your article last week that talked about giving your kids money – I liked that one,” she admitted.
So, today I’m going to talk more about giving kids money. Well, more accurately, I’m going to continue discussing income splitting with family members.
Last week, I introduced the concept of income splitting, which is the idea of moving income from your hands to the hands of a family member who will pay tax at a lower rate. The value of this varies by province and income level, but could save as much as $26,829 per family member in Ontario in 2014, or as little as $14,130 in Alberta. The average savings across Canada can be as high as $19,088 per family member in 2014.
The government’s “attribution rules” are designed to prevent you from moving income from your hands to the hands of your spouse or minor children. There are some exceptions to these rules. Here are some ideas for taking advantage of them.
1. Generate capital gains in the hands of your kids
Regardless of the age of your kids, there will not generally be attribution of capital gains on any money you’ve given them to invest; your kids will pay the tax. The best part is that your kids may pay little or no tax on those gains if they have little other income. Besides cash, you could also transfer existing investments to your kids. But beware: You’ll be deemed to have sold those assets at fair market value when transferring them. The tax cost, however, could pale in comparison to the taxes you could save.
2. Transfer any investment income to your adult child
If you transfer money to your minor children for investment, you’re going to pay the tax on any interest, dividends, rents or royalties (called “income from property”). Not so with adult children. Any income on assets given to a child 18 years or older (as of the end of the year) will avoid attribution, no matter what type of income. The only catch is that your child now owns and controls the assets. If this worries you, consider setting up a formal trust to maintain control over the assets. Finally, if you lend, rather than give, the money to your adult child and the tax collector decides that your primary motive was to avoid tax, the attribution rules will apply.
3. Give funds to your adult child, then charge room and board
When you give money to a child who has reached age 18 by Dec. 31, you’ll avoid attribution on any income earned. Of course, you may not want to give up the income you were enjoying on those investments. So, consider charging your adult child room and board for living at home. This can enable you to recover the income that you’ve given up by giving away your money.
4. Pay an allowance to your working child
Paying a child an allowance can make sense even after he or she is earning their own money. This will free up their earnings for investment. When they invest their own income, the attribution rules won’t apply and you’ll have effectively split income.
5. Make a corporate loan to a related student
If you’re a shareholder of a corporation, consider setting up a loan from the corporation to a student who’s not dealing at arm’s length with you. If the loan is not repaid within one year of your company’s year-end, the loan is going to be taxed in the hands of the student. But the student will likely pay little or no tax on the amount, if he or she has very little other income.
Once the student graduates and is earning a regular income, the loan can be repaid, and a deduction can be claimed by the student for the amount repaid. So, there’s little or no tax to pay when the loan is included in income, but a healthy deduction when it’s repaid later. Keep in mind that the company won’t be entitled to a deduction for the cash paid to the student. After all, it’s a loan.
Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.