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THE LEADING EDGE
A quarterly Newsletter for Certified Management Accountants
Published by the Society of Managenment Accountants in Nova Scotia, Bermuda and PEI
SUMMER, 1999
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Family Trusts: Still a Good Strategy
By CHRIS PALMER
The 1999 Federal Budget proposes to reduce the tax advantages of Family Trusts for income splitting.
Use of a family trust is a traditional method to take advantage of the low personal tax rates on dividends to "sprinkle" the income of a closely held corporation among family members, including minor children.
Old Rules
Here is a simple illustration of just one traditional way to use a family trust:
The assets of the business would be rolled tax-free to a holding company under Section 86 of the income tax act. The shares of the holding company would be held in the discretionary family trust for the benefit of the various family members, i.e. business owner, spouse, and children.
It is possible for an individual to earn around $24,000 of Canadian dividends without paying any tax. This is because the dividend tax credit would fully offset any tax owing, provided there were no other sources of income.
The advantages for a family are very obvious: issue up to $24,000 of dividends to each family member and none of them would pay tax (provided they had no other income). The result would be tax savings of up to $8,000 per child! The amount of income could different to each person if desired, because the trust was discretionary.
New Rules
The new rules affect the following income:
a) taxable dividends and other shareholder benefits from unlisted shares.
b) income from a partnership or trust providing goods or services to a business carried on by a relative of the child or in which the relative participates.
Any of the above two forms of income received by a minor child (under age 18) will be taxable to the child at the top marginal tax rate. In other words… no more tax-free dividend income for the minor children for the year 2000 and beyond.
While the advantages for minor children will be lost, family trusts are still a valuable strategy for 1999. After 1999 they will still be useful for income splitting with spouses, parents, adult children and other family members. They also remain beneficial for estate freezing, passing a business between family generations, multiplying the $500,000 lifetime capital gains exemption on small business corporations and qualifying farm property. Also, the new tax does not apply to interest income, so with a little creativity, minor children can loan money back to the company to be repaid with interest. Finally, the new tax does not apply to capital gains, and some strategies remain in that area too.
This information is of a general nature and is not tax advice to any party. Before acting, readers should seek advice that is appropriate to their own circumstances.
Chris Palmer, BBA, CMA, CFP is a Financial Advisor with Berkshire Investment Group Inc.
in Bedford, NS
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