In part 1 of this Canadian tax lawyer article on the use of family trusts for income splitting, we discussed the general set up of an income splitting family trust, and some of the tax planning traps to avoid. Part 2 of this income splitting article will review some more of the tax traps to avoid, and will discuss the Lifetime Capital Gains Exemption.
Care must be taken to avoid another major tax planning trap, the application of the “kiddie tax” contained in Income Tax Act section 120.4. The kiddie tax operates to tax the “split income” of a minor at the highest marginal federal tax rate, in the hands of the minor, unless they are enrolled as a full-time student at a post-secondary institution or disabled. The definition of “split income” in subsection 120.4(1) of the Act is lengthy but it is important to note that “split income” includes any income for the minor from the trust that “can reasonably be considered” to be in respect of taxable dividends from privately-held corporations. The application of the “kiddie tax” is not predicated on the source of income, as in the case of the above-noted attribution rules in section 74 of the Tax Act.
One final tax planning trap to beware is corporate attribution in subsection 74.4(2). Subsection 74.4(2) of the Income Tax Act can potentially result in adverse income tax consequences where property is transferred by an individual to a corporation, whether directly or indirectly including via a trust, and CRA can reasonably conclude that one of the main purposes of the transfer is to benefit a “designated person”, which is defined in subsection 74.5(5) of the Act to include a spouse and minor children. The effect of subsection 74.2(2) of the Act would be to deem transferors (usually one of the parents) to receive interest at the prescribed rate calculated on the value of the property transferred, adjusted for certain statutory offsets in paragraphs 74.4(2)(e)-(g). 74.4(2) is defined to have a wide scope and it is CRA’s position that it can apply to rollover transactions, such as a section 86 estate freeze often used to transfer assets into an income splitting family trust. However, where the corporations involved are small business corporations, Income Tax Act paragraph 74.4(2)(c) functions to completely avoid the application of the corporate attribution rules.
A further income tax planning benefit of a family trust is the possible multiplication of the Lifetime Capital Gains Exemption (LCGE). The LCGE allows for a deduction on the capital gain realized by a shareholder who has disposed of shares in a Canadian Controlled Private Corporation up to a limit prescribed by Parliament. As of 2014, the Lifetime Capital Gains Exemption was set at $800,000 and indexed to inflation. In 2017 the current permitted deduction is $835,715. Each of the beneficiaries of a family trust that owns shares that qualify for the Lifetime Capital Gains Exemption has the potential to claim the LCGE on the sale of the shares.
Our experienced Canadian tax lawyers can assist you in the planning and implementation of an income splitting family trust.
Go back to part 1 of Family Trust and Income Splitting.
Nathaniel completed his Juris Doctor degree at Osgoode Hall Law School where he excelled in the areas of tax law and legal writing and research.He successfully completed all of the requirements of Osgoode’s Taxation Law Curricular Stream
Carson Pillar articled with us and then joined our tax law firm as an associate Canadian tax lawyer having been called to the Ontario bar in June 2016. Carson runs our Calgary tax office. Carson earned his Juris Doctor from Western University and graduated in 2015.
Ian Thomas joined our Toronto tax law firm as an articling student (student at law) in July 2016 and upon becoming a Canadian tax lawyer in June 2017 he becomes our latest tax associate. Ian earned his Juris Doctor from Osgoode Hall Law School and graduated in 2016.
Tigra Bailey has now joined our tax law firm as a summer tax law student and is expected to return as an Articling Student in 2017-2018. Tigra is completing her Juris Doctor at Queen’s University and her expected graduation date is in 2017.
Ildi has joined the law firm of Rotfleisch & Samulovitch PC in June, 2000 and brings over 25 years of legal secretarial experience to the firm. She started as a Legal Secretary and after obtaining Certificates from The Institute of Law Clerks of Ontario
Jamin Chen joins our tax law firm as an articling student in September 2016 after earning his Juris Doctor from Allard Hall at the University of British Columbia.