Save tax by splitting income with children

December 18, 2020 • Inheritance, Tax Planning

When you think of income splitting, what first comes to mind is likely moving taxable income to a lower-income spouse. But several income splitting opportunities with children are available and worth exploring. The more income you can transfer to others in a lower tax bracket, the more tax you save as a family.

Tax savings with minor children

Under attribution rules, when you give a minor child investments or cash for investment purposes, all resulting interest and dividends are attributed back to you for tax purposes. But capital gains are taxable in your child’s hands.

A minor can’t have their own investment account, but you can invest on their behalf by opening an in-trust account at your bank or other financial institution, with your child as beneficiary. If you choose equity investments generating capital gains, tax will be payable to your child at their lower marginal tax rate. The account must be used to benefit the child, for example, to help cover post-secondary education costs.

In-trust accounts are relatively easy and inexpensive to set up, but the child controls the funds upon reaching the age of majority. You can gain more control over the assets by establishing a formal trust, which involves greater expense and legal guidance.

Keep in mind, too, that a Registered Education Savings Plan (RESP) is an effective income-splitting vehicle. For each child, you can contribute up to $50,000 that grows tax-deferred, with taxable portions of withdrawals taxed in the student’s hands. Often, no tax is payable, thanks to the basic personal tax credit.

Gifts to adult children

There is no attribution when you give cash or assets to an adult child – tax is not payable by you on any interest, dividends or capital gains resulting from the gift. This makes gifts to a child especially beneficial when a child is starting out.

Your child can open a Tax-Free Savings Account (TFSA) upon turning 18, but may not be ready to contribute for a number of years. You can gift cash to your child so they can make TFSA contributions and start saving for a car, home or any financial goal. Later, when your child enters the work force, they’ll start building Registered Retirement Savings Plan (RRSP) contribution room, but may not be in a financial position to contribute. But with a cash gift from you, they can begin saving for retirement in an RRSP, and you’ll have transferred your dollars to a tax-deferred environment.

Years later, you might gift funds that your child invests in a non-registered account, subject to tax at a lower marginal rate than yours. Perhaps you’ll even help your child make a down payment on a home, which could ultimately have no tax consequences with the principal residence exemption.

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