The so-called “kiddie tax” introduced in 2000 effectively eliminated the income tax advantages of corporate distributions to minor children. The effect of the tax resulted in distributions made to minor children being taxed at the top marginal income tax rate. While the advantage of making distributions to minor children was eliminated, corporate distributions to adult children (those 18 years of age and older) remains an attractive tax planning strategy.
Traditionally, an inter vivos family trust was created to hold shares of a corporation. Children (as well as spouses, grandchildren and other relatives) would typically be the beneficiaries of the trust. The directors of the corporation would declare dividends on the shares held by the trust. The dividends received by the trust would then be distributed as determined by the trustees of the trust to one or more beneficiaries of the trust. This tax planning strategy works particularly well to finance a child’s post-secondary education. The trustees can use their discretion to distribute income of the trust (received as dividends from the corporation) to the child. The income is then be taxed in the hands of the child at the child’s marginal tax rate. With the taxation rate on dividends coupled with available tax credits of the child including tuition, education and the basic personal credit, upwards to $30,000 can be distributed to the child without the child having to pay income tax. Compare this result with the alternative of a parent funding the cost. If the parent is at the top marginal tax rate, the parent would have to receive about $60,000 to end up with a net after tax amount of $30,000.
More recent tax planning includes the issue of a special class of shares which are issued to children. These so-called dividend sprinkling shares allow the corporation to pay dividends to adult children with the same after tax effect as with the family trust structure described above.
If shares have not been issued to children on incorporation of the corporation, a corporate reorganization may be undertaken to introduce children as shareholders of the corporation. Care must be taken with the reorganization to avoid attribution rules under the Income Tax Act which would have the effect of deeming the income received by the child as income of the parent (if an existing shareholder prior to the reorganization).