In the past, family trusts were used to provide a tax-effective way of splitting income with spouses and children. If properly structured, they could provide the following benefits:
- Allow for flexibility in the payment of dividends to different family members.
- Multiple access to the qualified small business capital gains deduction.
- Creditor proofing for cash presently accumulated in your company.
- A structure to minimize taxes paid by your family.
Measures have been introduced to eliminate many of the income-splitting benefits of family trusts and shareholdings by minors. But many of the above benefits are still available – just not to the same extent as in the past.
The new rules impose a kiddie tax on any child under 18 years of age who receives taxable dividends from a private corporation, either directly or through a trust or other structure.
The kiddie tax effectively charges the top marginal tax rate to the child on this type of income and, therefore, eliminates most of the tax savings accrued by income splitting with minor children.
Where a trust has already been set up with minor children as the beneficiaries and the trust holds shares in a private corporation, the structure may be able to be altered in order to retain some of its benefits. For example, where a trust holds the shares directly in a private operating company, a holding company can be placed between the operating company and the trust. The dividends from the operating company can then be paid into the holding company on a tax-free basis and held in the holding company until the beneficiaries of the trust are no longer minors.
Once the children turn 18 and the kiddie tax no longer applies, they may each receive approximately $50,000 per year in dividends without generating any tax liability (assuming they have no other income).
This applies to retirement planning as well. As an example, for those business owners who retire and have no other income, they could receive $50,000 in tax-free dividends on an annual basis from their holding company. So, if you and your spouse are shareholders of the holding company and neither has any other income from other sources, you both would be able to take a total of $100,000 in tax-free income on an annual basis as dividends from your holding company.
Tom Zaks is a seasoned portfolio manager and wealth advisor, a former business TV commentator, an experienced university lecturer, and the author of three wealth management books tailored to Canadian business owners. The above is an excerpt from his most recent book, The Business Owner’s Guide to Tax and Succession Planning.