Canadian tax law provides many good opportunities for parents to split income with their children and thereby save on income taxes.
You can start with the very first installment of the child tax credit after the child is born.
The rules say that any investment income earned on the child tax credit is not attributed back to the parents if the credit is deposited into an account in the child’s name.
This income has to be reported on a tax return for your child. As long as the child’s total income is lower than the basic deduction of around $8,600, the income will be tax-free.
This is one of the best ways for parents to start saving on a tax-free basis for a child’s education.
Another is the Registered Educational Savings Plan (RESP), which is not only a good opportunity to split investment income but also to get a government grant for your child.
You can put up to $4,000 a year for 10 years into an RESP and any investment income earned on this and the government grant (amounting to 20 per cent, up to $400, of the first $2,000 contributed each year) is sheltered from income tax until it is used to pay for post-secondary education.
When it comes time to pay for college or university, all of the parent’s contributions over the years can be withdrawn from the RESP tax-free, while the remainder, made up of investment income and government grants, is paid out to the child for education.
The child must report it as income in the year received but with the significant deductions available to the child from tuition and education credits, along with the basic personal deduction, little, if any, of this income would be subject to income tax.
Another strategy to split investment income involves the use of an in-trust account for the child, whereby the parent gifts money to the child and the money is invested in a special account managed by the parent but held in trust for the child. Income from the in-trust investment account is attributed back to the parent, but capital gains are taxed in the child’s hands.
By concentrating equity investments aimed at capital gains in the in-trust account and interest-earning investments in the RESP, you can have a balanced portfolio with little, if any, income attributed back to yourself.
Keep in mind that funds in an in-trust account belong to the child, who can take complete control of the money at age 18, and that RESP investment income, which stays under your control, would be subject to extra tax (on top of your normal income tax) if the child doesn’t use it for post-secondary education by age 25.
The KPMG Tax Planning 2006 guide cites other ways to split income with children. For example, for a child aged 17, you can give him or her funds to invest in GICs or bonds that mature after they turn 18. The interest income would then be attributed to the child.
The guide also suggests you consider lending your child, interest-free, an amount equal to what he or she earns over the summer and would otherwise spend. “This will allow the child to earn investment income on his or her own earnings, and the investment income will not be attributed back to you.”
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With respect to child care expenses, the guide notes that no deduction is allowed for payments made to a child under 18. Once your older child turns 18, if you are the lower-income spouse, you can claim amounts paid to him or her for child care services. Your adult child will need to give you a receipt and report the income for tax purposes.
While all these tax-saving strategies apply to everyone, parents who are entrepreneurs or own companies may have other options, such as making the child a shareholder of the business.
Also, a business owner can pay a salary or consulting fee to a child as long as the services are genuinely provided.
However, anyone contemplating one of these strategies may want to consult a tax specialist to learn how to set up a proper paper trail and to ensure it will pass scrutiny by a tax auditor.
Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.
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©2006 Wayne Cheveldayoff