INCOME SPLITTING: Tax Planning Lawyer
Neufeld Legal Professional Corporation
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INCOME SPLITTING

Income splitting is a tax planning strategy intended to shift income from a higher income earner to a lower income earner in order to reduce the overall tax paid by the family, which requires extremely particular rule adherence and as such appropriate professional counsel where the circumstances make such a process permissible.

For example, in particular instances, non-voting participating shares of a medical or dental professional corporation to be held by a professionalís spouse, children and parents. This permits family members who are not active in the professional practice to share a portion of the professional corporationís after-tax income by receiving dividends on shares that they directly or indirectly own. If these family members are 18 years of age or older, are in a low tax bracket and the corporation is properly structured, then the family, as a whole, will pay less tax than if the professional had earned all the income personally. Income splitting with children under 18 was severally restricted after 1999 as a result of amendments to the Income Tax Act. Those amendments (to what is known as the 'kiddie tax') were introduced to restrict the ability to split corporate income with a person under 18 years of age. To realize the intended benefits of these particular tax savings, where the specific circumstances make income splitting permissible, the structure should be utilizing the dependants' low tax rates without giving up all control over the money paid to the dependants. Therefore, rather than issue the non-voting participating shares of the professional corporation directly to the professionalís spouse and children, it may be preferable to issue the shares to a discretionary trust whose beneficiaries are the professionalís spouse and children. Such a structure, however, may be preferable for the following reasons: (i) the professionalís spouse and children will not have a direct interest in the shares individually, thereby isolating the shares from both the beneficiaries themselves and their creditors; and (ii) the trust can easily be dissolved by transferring its assets to one or more of the beneficiaries (for example, to the spouse) on a tax deferred basis and this might solve the problem of getting ďrid of the kidsĒ once they become self-sufficient. The disadvantage of using a trust is that it is more complex to administer and there will be annual costs associated with accounting for its transactions and filing its tax return.

An alternate approach to the use of a trust is the use of dividend sprinkling shares. Dividend sprinkling shares consist of numerous classes of common shares of which a separate class is issued to each family member and there is a specific power that permits dividends to be paid on any one class of shares to the exclusion of the others. While the CRA previously attacked the use of dividend sprinkling share structures, the validity of these structures has now been specifically sanctioned by the Supreme Court of Canada. Such a structure should be considered, instead of a trust, in cases where: (i) the professionalís children are very young. A trust generally distributes its assets every 21 years to avoid a deemed realization of its assets. To anticipate the effect of this distribution add 21 to the current age of each of the professionalís children and assess whether it is likely that the professional would be comfortable distributing shares to his or her children at that time; and (ii) it is unlikely that the professional will be able to accumulate significant assets in the corporation to pass on to the next generation. The real advantage of a trust over a dividend sprinkling structure is the ability to pass on future growth to the next generation. If there is no future growth, there would be no need for a trust structure. Although there is a substantial loss of corporate control associated with issuing shares directly to family members, many dividend sprinkling share structures provide for a special class of redeemable shares to be issued to the children so that the professional corporation can redeem the shares at a subsequent time with or without the childrenís cooperation. The advantage of paying dividends to family members rather than salary is that salary is subject to a reasonableness test. If the amount of any salary paid to a family member is more than what would be paid to a stranger, then the excess may not be deductible to the payor even though it is still income to the payee. It is not unusual for the CRA to assess penalties when lump sum amounts of salary are paid to minors. There is strong evidence that the CRA is currently taking a much more aggressive position with respect to the payment of unreasonable salaries to family members. There is no reasonableness test with respect to the payment of dividends.

For knowledgeable and experienced tax law representation when looking to develop and implement income splitting structures and other tax planning strategies, contact tax lawyer Christopher R. Neufeld at 403-400-4092 (Calgary, Alberta) / 416-887-9702 (Toronto, Ontario) or Lawyer@LawTax.ca.

NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as legal advice. You should not rely upon, or take or fail to take any action, based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. The law firm of Neufeld Legal PC would be pleased to discuss legal matters referenced in this website upon their retention in accordance with applicable requirements pertaining to client retention by this law firm.

 

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Tax Lawyer Christopher Neufeld with the business law firm of Neufeld Legal Professional Corporation, is admitted to practice law in Alberta and Ontario (Canada) and New York State (United States of America).  Christopher's legal practice focuses primarily on business law, in particular corporate commercial transactions and contract work  - directed at transactional tax optimization and effective tax planning. The content of this website is purely for informational purposes and should not be relied upon - as you should consult a lawyer with respect to the specifics of your particular legal matter.  Please review our legal disclaimer and privacy policy prior to contacting us and be advised that contacting us does not create a lawyer-client relationship. National headquarters: 1600, 144 - 4th Avenue SW, Calgary, Alberta. COPYRIGHT 2010-12.

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