Canadian Tax Primer 4: Sharing Income with University-Age Children

If you operate an incorporated business, you have lots of options to split income with other family members (including children who have turned 18).

You can have the corporation hire family members, but any salary paid to the family member cannot be higher than the salary that you would have paid to a non-family member for doing the same type of work.  If your child is away at university most of the year, you must reduce the amount of salary that you pay to the child accordingly.

A better option may be to have the corporation pay dividends to your child.  Dividends are a return on investment.  Your child can receive dividends even if she or he is hitting the university texts hard and doesn't work for the corporation at all.

Many parents are reluctant to have a child own shares directly in the business corporation.  This is where a trust can be useful.  If a properly-structured trust is established, the parents can be the trustees and manage the trust assets.  If the trust assets include shares of the corporation, the parents can control the shares as well as the dividends paid on the shares.  If the student achieves targeted grades, for example, the trust can pass dividends through to the child to assist with tuition and other expenses.  If the target grades are not achieved, however, the child has no right to receive anything from the trust.  If the parents are also beneficiaries of the trust, the parents can distribute the shares to themselves on the termination of the trust.  There is no risk of feeding a sense of entitlement.

Introducing a trust as a shareholder will usually require a corporate reorganization.  The trust itself must be established in a very specific manner in order to take advantage of the income splitting advantages.  If the parents want to be trustees, a parent would not usually establish the trust.  This is usually the role of the grandparent or some other close family friend.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

---

The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.

Canadian Tax Primer 3: Graduated Rates for Individuals

Canada uses a graduated rate system for individuals.  This means that the rate of tax increases as the overall level of taxable income increases.  For example, assume that you reside in British Columbia and that you have $75,000 of total taxable income.  Tax applies at a 20% rate on the first $37,869 of this taxable income, at a 23% rate on the next $6,800 of taxable income and at 30% on the rest.  So your effective tax rate is a combination of these various rates on the different portions of your income.

Because of the graduated rate system, it is much better to have two spouses each earning $75,000 in taxable income rather than a single spouse earning $150,000 (two times $75,000) in taxable income.

Various rules in the Income Tax Act make it difficult (but not impossible) to split income between spouses.  If a high-income spouse simply gifts money to a low-income spouse and the low-income spouse invests the gifted money, income earned by the low-income spouse on the gifted money will still be taxed at the rate of the high-income spouse.  However, there are ways around this rule.

In 2014, the federal government introduced a family tax cut credit.  This allows a couple with a child under the age of 18 to transfer up to $50,000 of taxable income from a high-income spouse to a low-income spouse.  However, the maximum tax benefit from such a transfer is limited to $2,000 in any one year.

In many cases, it is better for the high-income spouse to lend funds to the low-income spouse with interest.  The interest rate has to be at least equal to the Canada Revenue Agency prescribed rate of interest at the time of the loan.  As of the second quarter of 2015, this prescribed rate of interest is only 1%.  If the low-income spouse invests the loaned funds and earns a 4% return, the low-income spouse pays tax on a 3% return (after deducting the 1% interest paid to the high-income spouse).  While the high-income spouse pays tax on the 1% interest received, the high-income spouse avoids paying tax on the other 3%.

The loan has to be carefully documented and the low-income spouse has to actually pay the interest to the high-income spouse within 30 days of the end of each calendar year.  With proper structuring of the loan, the current 1% interest rate can be locked in for a considerable period of time (up to 20 or 25 years).  Over time, the low-income spouse can build up a significant investment portfolio so that the couple can split income even after the children have reached the age of 18 and the family tax cut credit is no longer available.  Furthermore, the amount of annual income tax that can be saved with the loan method is not limited to $2,000.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

---

The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.

Canadian Tax Primer 2: General Rules for Individuals

Canadian income tax is usually triggered by a specific event:  the earning of income.  Triggering events come in many different forms.  For an employee, the receipt of a paycheque triggers tax on the salary included in the paycheque.  For an investor, the sale of an investment will often trigger tax on any increase in value of the investment.

Income tax is calculated as a percentage of taxable income.  The applicable percentage depends on various factors, including the province (or territory) in which the individual resides or carries on business.

Canada is a federation consisting of a federal government (serving the whole nation), ten provincial and three territorial governments.  Each level of government imposes an income tax.  In order to determine the total amount of tax that you have to pay, you have to combine the federal income tax with the applicable provincial/territorial income tax.  As a result, the combined rate of income tax varies by province. 

For non-business income earned by an individual, the taxing province is the province of residence on the last date of the calendar year.  For business income, it is the province in which the business income is earned.  So an individual who resides in British Columbia will usually pay tax to the federal government and to the British Columbia government.  If the individual resides in Field, BC and is employed across the border at the Chateau Lake Louise, the individual will still pay income tax to BC rather than to Alberta.  If the individual decides to become an entrepreneur and starts his own unincorporated business selling ice cream to tourists walking around Lake Louise, however, he will have to pay Alberta provincial income tax on his Alberta business income (but will not pay BC provincial tax on that business income).

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

---

The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.