Income splitting using family trusts

Family trusts are often used to own shares in a private corporation. This can provide flexibility in the payment of dividends to different family members; a structure to minimize taxes paid by your family unit; multiple access to the qualified small business capital gains deduction (see topic 136); and some creditor-proofing for cash presently accumulated in your company.

However, there are rules to prevent income splitting with minors—these are referred to as the “kiddie tax” rules. These rules assess tax at the top marginal rate on taxable dividends from a private corporation received by any child under the age of 18. It doesn’t matter if the dividends are received directly or through a trust or other structure. The tax will also apply to income from property such as certain rental and financing income that is allocated to minor children. Income from property inherited from the minor’s parent is excluded from this rule. The “kiddie tax” also applies to capital gains allocated to a minor child from the disposition of shares to a non-arm’s-length person, provided dividends received on those shares would have been subject to the tax. New rules have also extended the tax to income paid to a minor from a trust or partnership if it is derived from a business or rental property for activities conducted with third parties, and a person related to the minor is actively engaged on a regular basis in the business or rental activity.

There is certain planning that can be done to deal with these rules. You should contact your tax adviser to review your situation and determine the best planning strategy.