Feb 03, 2010

Kiddie Tax

Possible tax savings opportunity

Effective January 1, 2000 amendments to the Income Tax Act made a direct attack on taxpayers who had been using family trusts and private corporations to split income with their young children.

Prior tax planning to avoid the attribution of income to a parent involved the setting up of a family trust which then borrowed a nominal amount of money and subscribed for shares in a private family-owned company. As the corporation prospered, the trust would receive dividends which would be taxed in the hands of the young children. This had the benefit of splitting the income and putting it into the hands of lower income taxpayers. The dividend income would not be attributed back to the parents, thus achieving income splitting. Using the child's personal exemption and the dividend gross up and credit, the minor could receive an income distribution of approx. $30,000/yr tax-free.

Another method was for a family trust to carry on the business of providing management services to a family-owned company or partnership, thus earning management fees.

The Kiddie Tax applies the top marginal tax rate (i.e. 40 - 50%) to minors who receive the type of income described above. As well, none of the regular credits or deductions will be available for this income.

NOTE: Specifically exempt from this rule is dividend income received from shares listed on a stock exchange.

Is there still an opportunity to save taxes?

Photography by Carissa Rogers