I have discussed the use of a family trust in two prior blogs –
Today, I have a back to school blog post on using family trusts to fund your child’s University education where one of the shareholders of your private corporation is already a family trust or you plan to introduce a family trust as a shareholder.
I know that many readers of this blog do not have private corporations. I apologize in advance for the restricted nature of this blog post. But, this is a case where those who operate through a corporate entity have a significant income tax planning advantage. As I noted in this blog post, personal income tax planning is a fallacy for most Canadians.
I don’t have to tell anyone that raising children is expensive. One of the largest expenses is education. For purposes of this blog post, I will ignore whether you feel as a parent your child should pay for some or all of their post-secondary education and assume you intend to pay for as much of that education as possible.
Most parents at a minimum utilize a Registered Education Savings Plan (“RESP”) to help fund their children’s educations. RESPs are excellent educational funding vehicles. The government provides grants, investment returns grow tax-free and the investment income is taxed in your child’s hands, when they eventually use the funds for post-secondary education purposes (typically resulting in minimal income tax).
However, in many cases, parents do not have the funds available to contribute to an RESP on a yearly basis, or, where they have large families or children pursue lengthy and/or multiple degrees, an RESP may be inadequate to fund all their children’s educational needs. A family trust can be utilized to either fully fund your children’s education or to fill the “funding gap”.
Family trusts are typically either introduced upon incorporation, where the family trust subscribes for the initial common shares issued by the corporation, or at a later date (usually as part of an estate freeze) where a family trust subscribes for new common shares in the corporation after the estate freeze or reorganization.
I discuss the concept of an estate freeze in the Introducing a Family Trust as a Shareholder in a Private Corporation blog I note above. But quickly, the intent of an estate freeze is to lock in the current fair market value of the shares held by the current owner(s), typically the parents into new special shares. As the special shares have a set fair market value, the parent’s future income tax liability is fixed based on the frozen value and any future growth of the corporation accrues for the benefit of the new common shares issued to a family trust or any new shareholder.
Whether a family trust acquired shares in the private corporation upon incorporation or upon an estate freeze is irrelevant; what is important is that once the family trust is in place and the corporation pays a dividend, the family trust can allocate the dividend it receives from the company to any beneficiary of the family trust that is 18 years of age or older (as a side note, when a beneficiary is allocated a dividend from the family trust when he or she is younger than 18 years, a punitive tax referred to as the “Kiddie Tax” eliminates much of the benefit of allocating dividends to these beneficiaries).
Assuming any part-time employment income the beneficiary child has earned during the summer or working part-time while at school is offset by the education tax credit he or she is entitled to as a result of the payment of tuition fees, a child 18 years or older can receive approximately $39,400 (in Ontario) in dividends from a private company tax-free. For example, if a family trust received dividends from the family business and allocates $39,400 to a child who is at least 18 years of age to pay for their University costs (tuition, books, rent, food, etc.) this could save the parent upwards of $12,000 in income tax. Alternatively, if a family trust allocated the $39,400 as two separate $19,700 dividends to two children over 18, no income tax would typically be payable. If a family trust receives $78,800 in dividends from the family corporation and allocates these dividends as $38,100 to two children, the parent could save as much as $26,000 in taxes.
It should be noted that there may be some tuition credits wasted under this plan when a dividend is paid (under the Income Tax Act, the tuition credits must be applied against taxable income until taxable income is nil, even if the credits are not required to reduce income tax to nil). If no dividend was paid, the child could potentially carryforward and/or transfer some of the credit to their parents. However, typically the forgone tax savings is minimal, but this issue must be considered.
Finally, parents must recognize that any money paid as dividends to your children, is legally their money. Thus, ideally, the money should be used to pay for University or College, to pay rent, to pay for a car, or any other expenses for the child. Any excess funds should be set aside for the child, maybe to help with a future house purchase.
There are many benefits of a family trust including the potential multiplication of the $750,000 capital gains exemption; however the funding of your children’s education is often the most practical and tax efficient.
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