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This post was contributed by Darren Swann, a Senior Manager with MNP's Tax practice in Drumheller, AB
Prior to 2000, a common income splitting strategy was to have minor children as shareholders in the family business - either directly or indirectly through the use of a family trusts. The parent’s corporation would then pay dividends to the minor children to take advantage of the fact that the child was in the lowest tax bracket. In some provinces, a child could receive as much as $30,000 of dividends per year without incurring any personal income tax.
On January 1, 2000, Parliament implemented legislation to prevent income splitting techniques to minor children, often referred to as “kiddie tax”. The “kiddie tax” applies on certain types of income received (“split income”) by a child under the age of 18. The types of income subject to kiddie tax included dividends from private corporations, shareholder loan benefits, and certain types of management services structures.
If a minor child does receive split income, they will be subject to the highest marginal tax rate in their respective province of residence. In addition, the child will not be entitled to use any personal exemption amounts to offset the taxes (i.e. Basic personal amount). The only relief on income subject to kiddie tax is the dividend tax credit and the foreign tax credit.
For example, if a minor child resident in Alberta receives a $10,000 dividend from the family corporation, they would pay $2,771 of kiddie tax on that dividend, even if they have no other sources of income. This is exactly the same rate of tax that their parents would pay on the same $10,000 dividend, assuming that they are in the highest tax bracket.
The Income Tax Act legislates that parents are jointly and severally liable for their child’s “kiddie taxes”. This gives the Canada Revenue Agency more power to collect on tax debts owed by the children.
Prior to the 2011 budget, taxable capital gains earned by a minor child was not subject to kiddie tax. As a result, there were many different planning ideas that triggered capital gains for the minor child by arranging for the child or a trust to sell shares of a private corporation to a parent or other related party. In the 2011 budget, the Federal government implemented further measures to apply kiddie tax to capital gains derived from the sale of private corporation shares to a person that does not deal at arm’s length with the child. Any such capital gains will be reclassified as a taxable dividend received by the minor and it will be subject to kiddie tax at the dividend tax rate.
The kiddie tax will not apply to capital gains realized by minor children from sale of publically traded stocks or on gains realized from the sale of private corporation shares to an arm’s length person.
Consideration should always be given to the legal consequences of issuing shares to children of any age. Some questions that you need to ask your legal and business advisor are as follows:
The kiddie tax legislation certainly dissuades parents from issuing shares to minor children. It may be better to explore other options such as paying a reasonable wage to a child that works in your family business. To learn about the tax planning options available to you and your family, please contact your local MNP Tax advisor.
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