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tax matters

The Bank of Dad is now open for business. I thought my kids were expensive when they were toddlers. Now that they're teens and pre-teens I realize that there's no way my kids are getting less expensive as the years go by. So, I was quite excited to learn about a new app, called "Bank of Dad," available for our iPad. It will allows me to track the total amount advanced to each kid – it's sort of an IOU tracker. "Dad, you don't want that app. It's boring," my oldest suggested yesterday. "Son, this app is sick," I replied. "And it's free!"

Don't get me wrong. I want to help my kids financially. If you're the same, there's a question to contemplate: Should you make a gift of money to your kids, or lend it to them? Before you decide which is best, you should understand the tax implications of each.

Gifts to kids

Let me start by saying that a gift of money to your adult children comes with no negative tax consequences. That's the good news. The bad news? Your child will be free to do whatever he wants with that money now that it's his or hers. If your child has their head screwed on right, you might not mind a gift to help pay for the cost of education, to buy a home, start a business, invest in a portfolio, or whatever else.

If your child is still under 18, however, a gift can still result in income taxed in your hands. If you gift money to your minor child and she earns "income from property" such as interest, dividends, rents or royalties, that income will be attributed back to you to face tax in your hands. Capital gains, however, will generally face tax in your child's hands.

Here's the deal: A true gift requires that you "divest, deprive or dispossess" yourself of title to the funds. If the funds are still effectively yours, the taxman may take the view that you never made a gift, and any income or capital gains on the money will be taxable in your hands whether your child is over 18 or not.

Loans to kids

Loans to children may be your preferred way to help, but the tax implications are a little more complex. Consider the following loans:

Loans for personal use: If you lend money to a child of any age to use for education, to buy a home, build a deck, buy a laptop or some other personal use, there is no tax issue to worry about.

Loans for business or appreciating assets: You can lend money to your child of any age to invest in a small business (or you can lend the money directly to your child's incorporated active business), or to acquire appreciating assets (i.e. to earn capital gains) and there is generally no tax problem.

Loans to earn income from property: If you lend money to your adult child so that he can earn income from property such as interest, dividends, rents or royalties, your child will generally pay the tax on that income – unless the taxman concludes that one of the main reasons for the loan was to have the income taxed in your child's hands, not yours. This may be tough for the taxman to prove, but you'd be wise to ensure you have other non-tax reasons for making the loan.

Loans for TFSA contributions: Our tax law requires that only the tax-free savings account holder make contributions to a TFSA. As a parent, you can't contribute to your child's TFSA on his or her behalf. So, those funds should be a gift, not a loan, to your child who can then contribute the funds to the TFSA on his or her own. This will avoid any potential issues with the Canada Revenue Agency refusing TFSA status for the account.

Loans for estate planning: If you hope to avoid probate fees at the time of your death by lending money to your children, rather than gifting assets to them, think again. A loan owed to you is still an asset of yours. So, the value of that asset may still be subject to provincial probate fees.

Loans to protect assets: If you are concerned about your children being subject to the claims of creditors or ex-spouses, lending money to a child and securing the loan with assets of your child (perhaps a mortgage on his or her home) can help to protect those assets from other claims.

More on this topic next time.

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