The Best of The Blunt Bean Counter- Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a June, 2012 post on whether your corporation's shareholder should be a family trust or holding company.

This determination is a very complex and requires analysis by a tax expert. If you are considering a family trust, you must obtain professional advice to ensure you do not trip over any tax "land mines".

Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?

I am often asked by clients incorporating a new company, whether they should hold the shares of the new corporation directly or whether they should utilize a holding company or a family trust.

The exact same question often arises a second time, years later, when a business has been successful and the shares of the corporation have been held by the client and/or their spouse directly and the client is now contemplating whether it makes sense to introduce a holding company or family trust into their corporate ownership structure, for creditor proofing and/or estate planning purposes.

I have discussed utilizing a holding company and introducing a family trust as a shareholder of a private corporation in prior blogs. Today I will discuss these alternative structures in context of a newly incorporated business and a mature business.

When a person decides to start a new business and incorporates (see my blog on whether to start a business as a proprietorship or corporation) there is often a level of uncertainty as to whether the new venture will be successful and cost control is often paramount. Thus, most people opt to keep their corporate structure simple (which really means, they do not want to spend money on lawyers and accountants to set-up holding companies and trusts) which is very understandable.

However, if you have the resources upon incorporation, you may wish to consider having a family trust own the shares of the private corporation rather than directly owning the shares or using a holding company from the outset. The two reasons you may wish to consider this corporate structure are as follows: (1) you can have a holding company as a beneficiary of a family trust which can provide all the benefits of a direct holding company; and (2) a family trust provides the ultimate in tax planning flexibility.

There are several benefits to having a family trust as a shareholder of your private company (I am assuming your corporation is an active company, not an investment company, for which the above is problematic). If the company is eventually sold, a family trust potentially provides for the multiplication of the $750,000 lifetime capital gains exemption on a sale of qualifying small business corporation shares (as of July, 2016, the exemption has risen to $824,177). That is, it may be possible to allocate the capital gain upon the sale to yourself, your spouse, your children or any other beneficiaries of the trust, resulting in the multiplication of the exemption and creating substantial income tax savings. For example: where there are four individual beneficiaries of a family trust, the family unit may be able to save as much as $700,000 (closer to $880,000 as of July, 2016) in income tax if a corporation  is sold for $3,000,000 ($3,300,00 as of July, 2016) or more . In addition, where your children are 18 years of age or over, the family trust can receive dividends from the family business and allocate some or all of the dividends to the children. The dividends must be reported in the tax return of the child, but in many cases, the dividends are subject to little or no tax (if a child has no other income, you can allocate almost $40,000 in dividends income tax-free).

Finally, where you have surplus earnings in a corporation and you wish to creditor proof those earnings, but do not want to allocate those funds to your spouse or your children, you may be able to allocate those funds tax-free to the holding company if it is a beneficiary of the trust. This provides for an income tax deferral of the personal taxes until the holding company pays a dividend to its shareholders.

So you may be asking “Mark, why would I ever not choose a family trust? Some of the reasons are as follows:

1. The initial accounting and legal costs may be as high as $8,000 - $12,000.

2. You may not have children or, if you do have children, they are young and you cannot allocate them dividends without the dividends being subject to the “Kiddie Tax” (a punitive income tax applied when minors receive dividends of private companies directly or through a trust).

3. You are not comfortable with allocating to your children any capital gains from a sale of the business and/or any dividends since legally that money would belong to them.
4. If the business fails, it may be problematic to claim an Allowable Business Investment Loss (a loss that can be deducted against any source of income) that would otherwise be available if the shares of the company were held directly by an individual.
5. There are some income tax traps beyond the scope of this blog post when a holding company is a beneficiary.

As discussed in the opening paragraph, once a business is established and has become successful, clients often again raise the issue of whether they should introduce a holding company or a family trust into the corporate ownership structure. At this stage, a holding company can easily be introduced as a shareholder. The mechanics are beyond the scope of this blog but the transaction can take place on a tax-free basis. However, the holding company essentially only serves one purpose, that being creditor proofing. A holding company is also often problematic, as the level of cash the holding company holds can put it offside of the rules for claiming the lifetime capital gains exemption if the business is sold in the future. Thus, you may wish to consider utilizing a family trust, unless you do not have children or do not anticipate being able to sell the corporation.

If one waits until the business is successful to introduce a family trust, as opposed to introducing one as an original shareholder when the business is first incorporated, the value of the business as at the date of the reorganization must first be attributed to the original owner(s) utilizing special shares (typically referred to as an estate freeze). This means the beneficiaries of the trust only benefit from the future growth of the corporation (i.e.: if the corporation is worth $2,000,000, the parent(s) are issued shares worth $2,000,000 and the children will only benefit on any increase in value beyond the $2,000,000). The costs of introducing a family trust with a holding company beneficiary as part of an estate freeze could be as high as $15,000 -$20,000 as a business valuation is often required.

The above discussion is very complex. The key takeaway should be that having a holding company as a direct shareholder of an operating company, may not always be the most tax efficient decision. A family trust with a holding company beneficiary may be the more appropriate choice depending upon the circumstances.

In any event, believe it or not, the above discussion has been simplified and you should not even consider undertaking such planning without consulting a professional advisor to understand the issues related to your specific fact situation to ensure the planning makes sense and that you are not breaching any of the hidden income tax traps.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Holding Companies – Issues to Consider

I have written several blog posts dealing with utilizing a holding company (“Holdco”) either directly as a parent company to your operating company (“Opco”) or indirectly as a beneficiary of a trust. These posts include:

Creditor Proofing Corporate Funds - This post discusses how a Holdco can protect surplus corporate funds and how for income tax purposes, the transfer of funds via a dividend from your Opco to the Holdco is in many cases tax-free (connected corporations).

Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company? - This blog examines some “fancier” tax planning to not only creditor proof funds, but allow for possible income splitting and multiplication of the capital gains exemption.

Corporate Small Business Owners: Beware; the Capital Gains Exemption is not a Gimme - This post explores the potential issues you may have in accessing the Capital Gains Exemption (“CGE”) including where your Holdco over time has accumulated too much cash and investment assets.

Because the concepts discussed in the blogs above are very complex (even for accountants), these posts have led to numerous questions by readers. In reading these questions, people are typically confused by the interaction of creditor proofing, income splitting and accessing the CGE, especially where they already have a Holdco in place with significant excess cash and/or investment assets. Thus, I thought today I would try and provide a bit of a road map for using a Holdco.

Working Backwards

Creditor Protection

The main reason small businesses owners typically consider using a Holdco in the first place is to creditor protect excess funds earned in their operating company. Most people find the concept of creditor protection (transferring cash and other assets from your Opco to remove the risk of someone suing Opco and making a claim on those assets) simple to grasp and in almost all cases; it makes business and income tax sense. Thus, I am assuming creditor protection is a given when considering using a Holdco.

Capital Gains Exemption

Where you do not think you can sell your business (the value of your business is just personal goodwill such as in a consulting business) a standard holding company often makes sense.

Where Holdco planning gets more complicated is when you want to ensure you have access to your CGE (while alive or when you pass away) and/or want to multiply the exemption and/or want to use your Holdco for income splitting purposes. The key concept to understand here is that; to access your CGE you or a family member must personally sell the shares of your Holdco (since you own the shares of your Holdco which in turn owns your Opco) and Holdco must meet various criteria to qualify for the CGE. If you have your Holdco sell the shares of your OPCO, there is no CGE, since it is a corporation selling, not an individual.

Situations Where you do not Currently have a Holdco in Place

If you currently own 100% of your Opco or own your Opco together with your spouse, you have a couple decisions to make before incorporating a Holdco.

Again, assuming creditor protection is a given, you need to determine if you think you will be able to access the CGE in the future. If the answer is no, you will probably be fine with a garden variety Holdco (Holdco owns 100% of Opco) especially if you already own Opco with your spouse.

Where you own Opco 100% personally and do not think you can access the CGE, you may want to give consideration to freezing (value of Opco is “frozen” at the current fair market value and you get special shares worth the frozen value) Opco and bringing your spouse in as a shareholder in Holdco. Again, in this situation, you would probably just use the typical Holdco/Opco structure with Holdco owning Opco 100%; however, you would have to concern yourself with ensuring you are not subject to punitive income tax rules, for which you would need income tax advice.

No Holdco in Place, but You may be able to Sell your Company in the Future to Access the CGE

Where you think your corporation is saleable to an arm’s length person in the future, the standard Holdco/Opco structure may not be appropriate, as damming cash in your Holdco may put your ability to claim the CGE in jeopardy.

In these cases, subject to your specific circumstances and only after consulting with your tax advisor, you may use either taxable dividends, stock dividends, an estate freeze or some kind of butterfly (a reorganization in which non-qualifying assets are transferred on a tax-free basis to a newly formed corporation, provided that no sale to an arm's length party of the shares of the small business corporation is contemplated at the time of the reorganization) to provide a structure that will allow Opco/Holdco to either constantly remain onside the criteria for the CGE or at least provide a mechanism to stay onside. Based on the recent Federal budget, your advisor may have to concern themselves with your company's safe income, in addition to the punitive rules I noted above.

As discussed in the “Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?”, where you have children (especially teenage children or older), it will often make sense to “freeze” the current value of your operating company to you and/or your spouse (if they have original ownership in the Opco) and have a family trust (with a holding company as a beneficiary of the family trust) as the parent of Opco.

Excluding the cost of undertaking this transaction, this structure can provide for multiplication of the capital gains exemption, income splitting (many parents use this structure to tax effectively pay for University) and creditor protection. The nuance here is that the Holdco is not the parent of Opco, but a beneficiary of the trust and therefore is not an impediment to accessing the CGE in the future. Once again, there are punitive tax rules to be wary of and tax advice is essential.

What if I Have a Holdco already in Place?

In situations where you already have a Holdco in place with significant assets, your planning is very complicated and fact specific and beyond the scope of this post. However, typically, subject to your specific fact situation, your advisor will likely suggest either a butterfly, freeze transaction, payment of a taxable dividend or use of a stock dividend that will allow for potential access to the CGE in the future. In cases of a freeze, this may mean you will be required hold the shares at least two years to qualify for the CGE.

I have attempted in this post to provide a bit of a road map for using a Holdco or a variation of a Holdco. However, this topic is extremely complex and fact specific and as such, I have not even got into the various punitive income tax provisions such as the corporate attribution rules amongst the various other punitive rules.

Thus, I cannot stress enough, that this entire blog is simplified and that you should not even consider undertaking any kind of Holdco planning without receiving tax advice from your accountant or tax lawyer.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Discretionary Shares – A Tool In Your Income Splitting Toolbox

When incorporating your small business (or in some cases your professional corporation), there are a multitude of issues to consider. Some of these concerns were discussed in my blog on Advice for Entrepreneurs. One of the most important decisions to be made upon incorporation is the determination of the corporate structure. Today, I will focus solely on the benefits of using discretionary shares in that corporate structure.

I have previously discussed using a family trust as the shareholder of a new entity in my blog post Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?
and thus, will not broach that topic today.

Discretionary Shares – What are They?

Discretionary shares allow a corporation to pay dividends on one class of shares to the exclusion of another class or at varying percentages. This concept is best illustrated through an example: If Mr. Bean has discretionary Class A shares and Mrs. Bean has discretionary Class B shares and the directors wish to pay a dividend of say $25,000, they could pay the entire $25,000 dividend to Mr. Bean and nothing to Mrs. Bean. Alternatively, they could pay the entire $25,000 to Mrs. Bean and nothing to Mr. Bean. They could also pay any other combination that totals $25,000; say $10,000 to Mr. Bean and $15,000 to Mrs. Bean, or $7,000 to Mr. Bean and $18,000 to Mrs. Bean.

This differs significantly from the standard garden variety common shares many lawyers automatically issue upon incorporation. Those shares pay dividends based on the ownership of the shares. So if Mr. Bean owned 35 common shares and Mrs. Bean owned 65 common shares, any dividends must be paid in the 35/65 ratio with no discretion.

The Income Splitting Benefit

Discretionary shares allow for income splitting with adult family members. Typically the shares are issued to the husband and wife or common-law spouses; however, in some cases it may make sense to issue shares to children, especially those 18 and over (the kiddie tax limits the benefits for children under 18).

The benefit is again best described by an example. Say Mr. Bean owns 75% of the common shares of Baked Beans Inc. and Mrs. Bean owns 25% of the common shares. Mr. Bean, as a working owner of the company, also receives a salary of $100,000. Under the above 75/25 ownership scenario, if a $100,000 dividend was issued and Mrs. Bean had no other income, Mr. Bean would pay approximately $27,000 in income tax on his $75,000 dividend (assume dividend is non-eligible), and Mrs. Bean would not pay any tax on her $25,000 dividend. However, if the shares had been set up as discretionary upon incorporation, the company could pay the entire dividend to Mrs. Bean and she would pay approximately $16,700 in tax, a $10,300 tax savings over standard common shares.

Another benefit of discretionary shares is that they can be issued to a holding company and used to creditor proof a company to ensure it qualifies for the capital gains exemption.

Why Not Always Use Discretionary Shares?

In some cases, spouses do not want their spouse involved in the corporate ownership; or if the spouses are involved, they prefer to own standard common shares, with at minimum 51% common share ownership. Not necessarily the best tax planning, but you would be surprised at how often people want this type of structure.

Be Careful

Care should be taken to ensure any other family corporations are not considered associated because of the discretionary shares; this would cause the corporations to have to share the $500,000 small business deduction.

While not relevant for a newly incorporated company; because of the income splitting opportunities afforded discretionary shares, the Canada Revenue Agency (“CRA”) has done some sabre-rattling with respect to the valuation of the shares when they are issued as part of an estate freeze. It is important in these cases that the fair market value (“FMV”) of the property is accurately determined.

Discretionary shares are a valuable tool in the income splitting toolbox. However, in order to ensure you handle that “tool” with care, you must obtain income tax advice before implementing any structure with discretionary shares.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Cottage Trusts

Last week Katy Basi wrote a blog post on the various estate planning challenges in passing on your cottage to your family. Today, in part 2 of her series, Katy discusses the use of cottage trusts to facilitate the transfer of your cottage. I thank Katy for her excellent series.

Cottage Trusts

By Katy Basi

 

This blog is a follow-up to my previous blog on the topic of inheriting a cottage, cabin or chalet. There are three main reasons that I have come across for a cottage in Ontario to be owned by a trust:

1) Minimization of estate administration tax, aka probate tax. Ownership of a cottage by a trust was a popular strategy in Ontario in first half of the 1990’s as a way to avoid having to pay probate tax on the value of the cottage. (In the first half of the 1990’s the Ontario government increased the rate of probate tax from its then fairly negligible rate to its current level (1.5% of the fair market value of an estate over $50,000)). A number of cottage owners were convinced to transfer the cottage to a trust in order to avoid probate tax on the value of the cottage upon their death. Many of these trusts are now reaching their 21 year anniversary. Without professional planning, a cottage trust will be required to pay tax on any accrued capital gain on the cottage due to the “21 year deemed disposition rule”. Given the increase in Ontario cottage prices over the last 21 years, very significant tax bills could result. There is often planning that can be undertaken to avoid this capital gain, usually involving a transfer of the cottage to one or more beneficiaries of the trust, but this planning must be undertaken a number of months before the 21st anniversary. If this is your situation, do not delay in getting professional advice!

2) Protection from having to share the value of the cottage upon separation or divorce. As noted in my previous cottage blog, a cottage often qualifies as a matrimonial home for family law purposes, in which case the value of the cottage is shareable upon a separation or divorce (as part of a process called “equalization”). If the cottage is instead owned by a discretionary trust, with a number of beneficiaries, and no guaranteed right of the beneficiaries to any of the income or capital of the trust, the argument can be made that none of the beneficiaries actually own the cottage or have any right to the cottage that can be valued, so that no equalization payment should be made. I advise my clients that a family court may “look through” any trust, including a cottage trust, and allocate a value to a discretionary trust interest. However, if three siblings would otherwise co-own a cottage, each having a one-third interest subject to potential equalization, this situation may be ameliorated by having a discretionary family trust own the cottage with the three siblings as trustees, and the siblings and all of their children as potential beneficiaries. If each sibling has two children, there will be 9 beneficiaries. The value of a 1/9 interest in the trust will be far less than the value of a 1/3 direct ownership interest, and there is a chance that a sibling’s interest will be valued at nil due to the discretionary nature of the trust.

3) “Wait and see” trust. When a cottage owner wants to give their children the option of inheriting the cottage, but is unsure as to whether the children will be able to deal with the practical issues of cottage ownership, and the even greater challenges of cottage co-ownership, a “wait and see” trust may be a good option. The cottage owner leaves the cottage to a cottage trust in his or her Will. The cottage trust is structured to last for the length of time that the parent thinks will be required for the children to figure out a workable long term plan for the cottage. If there are sufficient funds in the estate, the parent may leave a “cottage maintenance fund” as part of the cottage trust in order to reduce the financial burden on the children of maintaining the cottage for the duration of the trust. Upon the termination of the cottage trust, the children figure out if they will co-own the cottage, whether one child will buy out the other children’s interests, or whether the cottage will be sold to a third party.

Transferring a cottage to a trust during the lifetime of the owner can trigger capital gains tax, unless the trust qualifies as an alter ego trust or a joint partner trust. In addition, the trust itself is a separate taxpayer which pays tax at the highest marginal rate, resulting in higher tax bills, under certain circumstances, compared to ownership by the previous owner. Cottage trusts are often created in the Will of the cottage owner as a method of assisting the beneficiaries to keep the cottage in the family, given that any accrued capital gain on the cottage is taxable upon the death of the owner in any event (especially where the owner does not leave the cottage to his or her spouse). Cottage trusts are not appropriate for all situations, but they can be a lifesaver under the right circumstances.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estate planning, estate administration and income tax law. Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@katybasi.com. More articles by Katy can be found at her website, katybasi.com.

The above blog post is for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Readers are advised to seek specific legal advice regarding any specific legal issues.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Why Spend Your Energy Being Frugal? Just Tax Plan!

This past February, I had some fun with a top ten list (look below the sports agent's fees post) on why you should vote for me in a blogging contest (thanks to all of you who helped vote me into the second round of the contest!). In this list I took some shots at frugal blogs and got some emails from furious Frugalites asking me what I had against frugality and frugal blogs? I responded to a couple of emails saying that I don't have anything against frugal bloggers or frugal blogs in particular: my issue is that I think people are far too focused on cost savings,
as opposed to increasing income and/or minimizing income taxes.

As per this tongue and cheek blog I wrote titled “Old and Not Thrifty”, I admit I am not thrifty, although my wife counterbalances my lack of frugality with her ability to get a great deal. Notwithstanding my personal spending habits, any long-time reader of The BBC will know I often write about how important it is to budget and spend within your means and I reiterate this now – always be cognizant of what you are spending. However, in my opinion, if you budget well and are frugal, I think you reach a point of diminishing returns. So you save $12 on a cheaper toaster, or $1.29 on a box of cereal. Yes, those are savings, but they are immaterial in my mind once you have already proven to be a disciplined spender. Why not put all that energy into producing more income or saving taxes?

Before you start sending me hate mail, this post is not intended for those whose financial situations are such that frugality is a necessity, but for those of moderate or greater income who seem to get a little carried away with their frugal efforts when they could be making a bigger change in another manner.

I can already hear the cries of “Mark don’t give me the you should earn more lecture. I am stressed out as it is with my current job and life.” So, I won’t tell you to consider turning a hobby or an expertise into a side business or to spend some energy creating a case for a raise from your current employer or to spend your energy looking for a better job opportunity. Nope, I am going to give you some lazy tips from my past blog posts to save you significant money in taxes so you won’t have to worry about saving money on the daily fresh fish special (if you call a fish floating with one gill above the water, fresh).

I have reviewed my past blog posts to unearth three effective if not fairly effortless ways to increase your cash-flow:

1. Capital Loss Planning

I have written several times about capital loss planning (see the third paragraph from the bottom of the post, “Creating Capital Losses – Transferring Losses to a Spouse Who Has Gains) where you have a capital gain and your spouse has an unrealized capital loss. If your situation meets the criteria in my post and you have, say, a $10,000 loss and your spouse has a gain greater than $10,000, you could potentially save almost $2,500 by undertaking this form of tax planning. That is a lot of cheap rolls of toilet paper. The only caveat for this tip is that you should probably get some professional advice to ensure you do not get tripped up by the technical rules with superficial losses.

2. Form T2200

How about spending your energy asking or prodding your company to provide you with a T2200 Form that allows you to claim your employment expenses. Many employees are shy about requesting these forms and many employers are reluctant to issue these forms (because of the administrative hassle). If you incur expenses such as automobile costs, telephone or home office costs and are not reimbursed or only partially

reimbursed, ask or convince your employer to issue this form so you can deduct any of your employment related expenses on your 2013 personal income tax return. Depending upon the amount of employment expenses you have been personally absorbing, you may save enough for a vacation, which to me is a lot more exciting than saving some money on steaks that expire that day.

3. Income Splitting with Your Spouse

Income splitting can be as simple as spending the higher income spouse’s money on living costs and using the lower income spouse’s salary to invest, so any investment income is earned by the lower tax rate spouse. Alternatively, income splitting can be as sophisticated as utilizing a family trust or a prescribed loan, the rate is currently only 1%.

I have just briefly touched on a few simple opportunities to save money through tax planning. My point? Frugality takes a lot of time and effort, whereas many tax planning strategies require only a few hours of consideration. Even if you require an hour of time from an accountant to review your plan, the tax savings can be substantial.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Prescribed Rate Loans Using a Family Trust

In July 2011, I wrote about the income tax savings that may be derived by using a 1% prescribed interest rate loan to income split with your spouse and children. As the world economies would have it, interest rates have not moved very much over the last eighteen months; consequently, the Canada Revenue Agency (“CRA”) prescribed interest rate is still 1% for this quarter. I would therefore suggest that the use of a prescribed interest rate loan is still an attractive tax planning alternative, however, today I will expand the use of these types of loans to include a loan to a family trust for purposes of income splitting.

To recap the above blog post. The Income Tax Act contains income attribution rules that typically reallocate income to the higher income earner when he or she tries to income split with his or her spouse or children. However, there is an exception to the above attribution rules where an individual makes a loan to a spouse or minor child and interest is charged on the loan at a rate at least equal to the CRA’s prescribed interest rate at the time the loan was made. Where the loan carries interest at a rate no less than the prescribed interest rate, the attribution rules will not apply. For the loan to avoid the income attribution rules, the interest owing must be paid each year within 30 days after the end of the year (i.e. January 30th).

As I noted at the end of the blog post, income splitting with minors can be problematic because minors generally cannot enter into an enforceable contract. Thus, I suggested the use of a family trust to navigate the enforceability issues. Today, I want to expand on the use of a family trust for these type loans.

Using a Family Trust

Where a family trust is a shareholder in your company, the kiddie tax rules make income splitting with beneficiaries problematic and typically the trusts are only beneficial for children once they turn 18 or where the company is sold and you can "sprinkle" the $750,000 capital gains exemption amongst your family members.

Shockingly, for once, individuals have a planning advantage over corporations. Where you do not have a corporation or the circumstances don’t allow for the introduction of a family trust as a shareholder of a corporation, a family trust can still be utilized to income split, by utilizing a prescribed interest rate loan to a family trust. The beauty of making a prescribed loan to a trust is that the kiddie tax will not be applicable and if structured properly, children under 18 who are beneficiaries of the trust can be used to income split. 

To prevent any confusion, let me clarify. A family trust is not an “in trust” account that some institutions allow. What I am talking about here is a formal discretionary family trust governed by a trust agreement or trust deed drafted by a lawyer and properly settled, often by a grandparent. The beneficiaries of a family trust in the case of a prescribed loan trust would include both minor children and children 18 years of age and over and the trustees would typically include at least mom or dad, if not both, and an arm’s length third party.

Once the family trust is settled, mom or dad makes a loan to the trust at the prescribed interest rate in effect at the time of the loan (i.e. 1% if the loan was made this quarter). It is very important to understand that the Income Tax Act requires that the loan carry an interest rate at least equal to the prescribed rate at the time of the loan and that this interest rate remains in effect the entire time the loan is outstanding. Thus, the 1% interest rate will not change as long as the loan is in existence, even if the CRA’s prescribed interest rate increases in the future. I cannot emphasize what a huge benefit the low permanent interest rate is in our current low rate environment. If rates begin to rise, the trust will continue to only pay 1% interest, yet the family trust can earn say 7% interest without the risk that would be required today to try and achieve a 7% return.  

Once the trust receives the loan proceeds, it will then invest the funds, but must  pay mom or dad the 1% interest by January 30th of the following year. Mom or dad must report the interest earned on the loan in their personal income tax return and the trust is entitled to an interest expense deduction for the interest paid.

The income earned by the trust less the interest expense paid is then allocated out to the children and is taxed in their hands, which in most cases will result in no income tax.

The trust can be used to pay the children’s school costs, camp costs, etc.

So why isn't there a proliferation of family trusts used for income splitting of investment income? Well, the legal and accounting costs of setting up the trust can range from $4,000 to $8,000 give or take and there are also annual T3 Trust filing costs charged by an accountant. In addition, as noted yesterday, in order to make this worthwhile, the parents would typically need to advance at least $500,000, but probably closer to $1,000,000 in this low rate environment to make the additional income tax filings and administration costs worthwhile. However, you could establish or settle a trust and loan it, say $100,000 today, to lock in the 1% rate, if you believe the compounding effect of the invested money will provide you with significant investment income down the road or you expect the stock market is going to go gangbusters in the near future. Remember though, any loans advanced to the trust in the future will need to carry an interest rate at least equal to the prescribed rate at that time, so if you loan the trust more money in the future and the prescribed rate increases to say 5%, the additional loan will be subject to the higher interest rate.

Where you have funds available for investing and have children with significant private school or university costs, then you should consider the creation of a family trust and the use of a prescribed interest rate loan for income splitting purposes. Alternatively, you can just use the trust to build up funds in your child's name to help them buy a car or a house.

Tax planning of this nature is very complicated as you must navigate several income tax and trust law provisions to ensure compliance. Before considering tax planning of this nature, you must consult with an accountant and/or lawyer.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Paying for Private School with Tax-Free Money – Got an Extra Million?

A few weeks ago, there was an advertisement in a national newspaper by one of the large banks wealth management divisions, about utilizing a family trust to pay for private school tax-free. The advertisement went on to note how this trust could not only help fund a child's/grandchild's private school costs, but how the trust could allow parents and grandparents to retain control over their initial capital.

I had two clients call that morning asking about the advertisement and what it entailed. One client already had a variation of the planning vehicle in effect. With the other, we had discussed the idea a while back and it was not adopted, but in both cases, the advertisement caught their attention even though they were unsure what exactly was being proposed.

I thought this advertisement was a brilliant piece of marketing by the financial institution and the related investment advisor. The headline sensationalized the term "tax-free" and hit upon a sore spot for many high net worth people, the after tax cost of their children's private schooling, for which a family trust can be an effective vehicle to reduce such costs. However, the issue with the advertised trust or any trust that I propose to one of my clients is: how much money do you need to establish the trust? I would suggest that in this low interest rate environment, you would require at minimum $500,000 in free cash, but more likely $1,000,000 for this plan to be cost effective.

If you have been a loyal Blunt Bean Counter reader, you already know about family trusts. I have discussed the use of family trusts on several occasions and even looked at how they would be beneficial in the payment of university costs.

The key to the advertised family trust is that capital gains generated inside the trust can be distributed tax-free or nearly tax-free to children or grandchildren who have little or no other income. Depending upon the manner in which the trust is established, dividend and interest income that is allocated to a child under 18, may or may not be distributed tax-free and may or may not create income attribution issues that negate the value of the trust (see my blog post tomorrow).

For the purpose of today's blog post, I will just concentrate on capital gains and ignore interest and dividend income for now.

If a trust is settled with or loaned $500,000, it would need to realize around 5% yearly capital gains appreciation to earn $25,000 in capital gains, an amount that could be distributed essentially tax-free ($250 or so of tax) to a child to pay for their private school if they have no other income.

That sounds pretty good (assuming you can realize 5% in capital gains each year, easier said than done). However, we have not accounted for the fact that $25,000 in capital gains transferred to your children or grandchildren would only save the parent/grandparent approximately $6,000 in tax (at the highest marginal tax rate). The tax benefit is reduced further by the cost of establishing the trust, any fees you would have to pay the financial institution for administering the trust and the fees you pay your accountant for filing the trust tax return. I would therefore suggest that for this type of planning to be cost effective, the parent or grandparent would need to loan or settle the trust with an amount in excess of $500,000, maybe even $1,000,000 to make this a worthwhile tax vehicle. If you don't have $500k lying around, you could establish the trust with a lesser amount using a prescribed rate loan to lock in the 1% prescribed rate, however, I would still question the tax and cost effectiveness of such a move. I'll discuss these details tomorrow.

I have not reviewed the details of how a family trust works here; you can read the links above if you would like to get up to speed. Tomorrow, however, I am going to post a blog on using a prescribed rate loan to fund a family trust that can be used to help pay for private school, university or any other costs your child has, which is probably very similar to what that financial institution's trust does. See you tomorrow.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Salary or Dividend? A Taxing Dilemma for Small Corporate Business Owners

Over the last couple years, tax professionals have questioned the traditional salary based remuneration strategy used to pay corporate small business owners. Numerically, there is hard evidence that a remuneration strategy of paying only dividends and not paying any salary results in an absolute income tax savings and potentially, greater long term retirement savings. However, foregoing a salary means you can no longer contribute to a Registered Retirement Savings Plan (“RRSP”), nor can you contribute to the Canada Pension Plan (“CPP”). In addition, although abstruse in the salary versus dividend analysis, one must somehow account for personal behavioural characteristics. A consequence of utilizing a dividend only strategy is that you “park” your retirement savings in an easily accessible and tempting location (an operating company or a holding company) and human nature being what it is, one may tend to stick a hand in the candy bowl (money bowl in this case) when there is candy (money) there for the taking.

One of the first professional advisors to advocate the use of a dividend only strategy was John Nicola of Nicola Wealth Management. John’s views were discussed in a provocative 2010 article on “Paying yourself in dividends” by David Milstead of the Globe and Mail. I say provocative (since as my friend Alison says, "I find money pretty darn sexy"), because I specifically remember several people calling me to ask my opinion on the article.

Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC was another early proponent of using a dividend only strategy, or at least considering using such a strategy. In 2010, Jamie wrote an excellent report “Rethinking RRSPs for Business Owners: Why Taking a Salary May Not Make Sense” in which he concluded it may be better to not contribute to an RRSP, but  to essentially create your own “corporate RRSP” by utilizing a dividend only strategy.

Jamie followed up a year later with another paper, this time titled “Bye-bye Bonus! Why small business owners may prefer dividends over a bonus”. In this report, Jamie concluded that a dividend remuneration strategy may be the preferred method of remuneration in many cases for small business owners.

As evidenced by the breadth and depth of Jamie’s reports, this topic is not conducive to a simple analysis. Thus, in order to make this topic more digestible, I have broken the topics on remuneration strategies for corporate small business owners into three separate blog posts:

1. Conventional Wisdom

2. Salary or Dividend - The Numbers

3. Salary or Dividend - Issues to Consider

Conventional Wisdom

So let’s review the so called “conventional wisdom” with respect to how most accountants advise or used to advise their clients to pay and/or distribute their remuneration.

For individuals who operate an active business through a corporation and whose corporation has annual taxable income of less than $500,000, most accountants generally advise or used to advise, a remuneration strategy along these lines:

1. Pay yourself a salary to maximize your RRSP contribution room for the following year (A 2013 salary of $134,833 is required to ensure you will have the ability to contribute the maximum 2014 RRSP deduction of $24,270).
2. Pay reasonable salaries to your spouse and children if they work in the business.
3. Pay dividends to the owner-manager and/or their spouse and children (if shareholders or beneficiaries of a family trust) to fund any additional living expenses not covered by salary.
4. Leave any remaining funds in your business to defer income tax on those funds. This strategy will be discussed in greater detail tomorrow.

Where a corporation has taxable income in excess of the $500,000 small business deduction (“SBD”) limit, the “conventional wisdom” used to be to pay a salary to maximize the business owners RRSP and then pay an additional bonus equal to the corporation’s taxable income in excess of the $500,000 limit (i.e. Pay a bonus to reduce the corporations taxable income to the $500,000 threshold limit at which the corporations income is taxed at a favourable low rate [15.5% in Ontario]).

However, as corporate income tax rates have declined over the last few years, “conventional wisdom” has changed with respect to paying a bonus when the corporate taxable income exceeds the $500k SBD limit. Most accountants continue to advise their clients pay a salary to maximize their RRSPs, but many now suggest their clients pay the higher general rate of corporate income tax (26.5% in Ontario) when taxable income is greater than $500,000 rather than pay the additional bonus, if the money is not needed immediately. The reason for this is to take advantage of the 19.91% income tax deferral (46.41% highest non "super tax" personal tax rate - 26.5% corporate rate in Ontario) or 23.03% deferral at the "super tax" rate. Our firm calculates that if your anticipated after-tax investment return is 3%, this strategy makes sense even if you can only leave the money in the corporation for 2 to 3 years.

For the purposes of this blog post and my two upcoming posts, I will not comment any further in regard to private corporations with taxable income greater than $500,000 as many accountants tend to agree on the above remuneration strategy.

Tomorrow, I put on my bean counter hat and throw some numbers around.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Private Corporations - Using a Family Trust to Fund University Costs

I have discussed the use of a family trust in two prior blogs – Introducing a Family Trust as a Shareholder in a Private Corporation and Should Your Corporation’s Shareholder be a Holding Company or a Family Trust?

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.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?

I am often asked by clients incorporating a new company, whether they should hold the shares of the new corporation directly or whether they should utilize a holding company or a family trust.

The exact same question often arises a second time, years later, when a business has been successful and the shares of the corporation have been held by the client and/or their spouse directly and the client is now contemplating whether it makes sense to introduce a holding company or family trust into their corporate ownership structure, for creditor proofing and/or estate planning purposes.

I have discussed utilizing a holding company and introducing a family trust as a shareholder of a private corporation in prior blogs. Today I will discuss these alternative structures in context of a newly incorporated business and a mature business.

When a person decides to start a new business and incorporates (see my blog on whether to start a business as a proprietorship or corporation ) there is often a level of uncertainty as to whether the new venture will be successful and cost control is often paramount. Thus, most people opt to keep their corporate structure simple (which really means, they do not want to spend money on lawyers and accountants to set-up holding companies and trusts) which is very understandable.

However, if you have the resources upon incorporation, you may wish to consider having a family trust own the shares of the private corporation rather than directly owning the shares or using a holding company from the outset. The two reasons you may wish to consider this corporate structure are as follows: (1) you can have a holding company as a beneficiary of a family trust which can provide all the benefits of a direct holding company; and (2) a family trust provides the ultimate in tax planning flexibility.

There are several benefits to having a family trust as a shareholder of your private company (I am assuming your corporation is an active company, not an investment company, for which the above is problematic). If the company is eventually sold, a family trust potentially provides for the multiplication of the $750,000 lifetime capital gains exemption on a sale of qualifying small business corporation shares. That is, it may be possible to allocate the capital gain upon the sale to yourself, your spouse, your children or any other beneficiaries of the trust, resulting in the multiplication of the exemption and creating substantial income tax savings. For example: where there are four individual beneficiaries of a family trust, the family unit may be able to save as much as $700,000 in income tax if a corporation  is sold for $3,000,000 or more. In addition, where your children are 18 years of age or over, the family trust can receive dividends from the family business and allocate some or all of the dividends to the children. The dividends must be reported in the tax return of the child, but in many cases, the dividends are subject to little or no tax (if a child has no other income, you can allocate almost $40,000 in dividends income tax-free).

Finally, where you have surplus earnings in a corporation and you wish to creditor proof those earnings, but do not want to allocate those funds to your spouse or your children, you may be able to allocate those funds tax-free to the holding company if it is a beneficiary of the trust. This provides for an income tax deferral of the personal taxes until the holding company pays a dividend to its shareholders.

So you may be asking “Mark, why would I ever not choose a family trust? Some of the reasons are as follows:

1. The initial accounting and legal costs may be as high as $7,000 - $10,000.

2. You may not have children or, if you do have children, they are young and you cannot allocate them dividends without the dividends being subject to the “Kiddie Tax” (a punitive income tax applied when minors receive dividends of private companies directly or through a trust).

3. You are not comfortable with allocating to your children any capital gains from a sale of the business and/or any dividends since legally that money would belong to them.

4. If the business fails, it may be problematic to claim an Allowable Business Investment Loss (a loss that can be deducted against any source of income) that would otherwise be available if the shares of the company were held directly by an individual.
5. There are some income tax traps beyond the scope of this blog post when a holding company is a beneficiary.

As discussed in the opening paragraph, once a business is established and has become successful, clients often again raise the issue of whether they should introduce a holding company or a family trust into the corporate ownership structure. At this stage, a holding company can easily be introduced as a shareholder. The mechanics are beyond the scope of this blog but the transaction can take place on a tax-free basis. However, the holding company essentially only serves one purpose, that being creditor proofing. A holding company is also often problematic, as the level of cash the holding company holds can put it offside of the rules for claiming the $750,000 lifetime capital gains exemption if the business is sold in the future. Thus, you may wish to consider utilizing a family trust, unless you do not have children or do not anticipate being able to sell the corporation.

If one waits until the business is successful to introduce a family trust, as opposed to introducing one as an original shareholder when the business is first incorporated, the value of the business as at the date of the reorganization must first be attributed to the original owner(s) utilizing special shares (typically referred to as an estate freeze). This means the beneficiaries of the trust only benefit from the future growth of the corporation (ie: if the corporation is worth $2,000,000, the parent(s) are issued shares worth $2,000,000 and the children will only benefit on any increase in value beyond the $2,000,000). The costs of introducing a family trust with a holding company beneficiary as part of an estate freeze could be as high as $15,000 -$20,000 as a business valuation is often required.

The above discussion is very complex. The key takeaway should be that having a holding company as a direct shareholder of an operating company, may not always be the most tax efficient decision. A family trust with a holding company beneficiary may be the more appropriate choice depending upon the circumstances.

In any event, believe it or not, the above discussion has been simplified and you should not even consider undertaking such planning without consulting a professional advisor to understand the issues related to your specific fact situation to ensure the planning makes sense and that you are not breaching any of the hidden income tax traps.

Top Canadian Investing Blogs

If you are still reading at this point (yes, I know, I break every rule about having a maximum of 400 words per blog), Jeremy Biberdorf of www.modestmoney.com has been kind enough to nominate my blog in his poll for the top Canadian Investing Blogs (not sure my blog fits that category, but I appreciate the consideration anyways). If you have a minute, please visit this link and vote for me. My goal is to escape last place :).

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Tuition in Canada -At least my Kid does not go to School in the States

I am back, in a less cranky mood than on Friday (as today is the last day of income tax season). Today will also be my last blog for a week or so, as I am off for some R&R later in the week. Over the next few weeks, I need to refine the focus and purpose of this blog. To date, I have been pleased with the response to the blog, but I know I cannot commit to being a four or five day a week blogger. I do know that I want to try and have more original pieces than comment pieces, so I have a direction, it just needs need refinement. Anyways, enough navel gazing. For those of you with kids in university, or more specifically, saving to send your children to university, read on; although you may want to keep an air sickness bag nearby when you read the numbers detailed below.

Tuition in Canada -At least my Kid does not go to School in the States

I cannot believe the university school year is already over and my kids are returning home. This year I officially became an empty nester as my daughter marched off to university joining my son who just finished his third year. While my wife and I had different feelings upon my daughter leaving – my wife was sad and I was ecstatic - sorry kids if you are reading this, but I can only listen to you tell me that I know nothing for so long - my wife and I were both in sync on our reaction to the combined tuition bill, total shock.

You see, my son had switched at the last moment from a general science program to the Ivey business program at Western. The combined cost for my son and daughter including rent and food was in excess of $50k. My RESP quickly looked a little light. 

For a child living in residence at most Ontario schools you are looking at around $16-18,000 a year for residence, food, books and tuition. Computers add an additional cost. As for Ivey, they even warn you of the estimated cost of $37,000 for academic and living expenses on their website.

So for a child who does two years of undergrad and an Ivey HBA (I won’t even tell you what my son’s ultimate university plans are), the cost is in the range of $110,000. For a four year undergrad only, the cost is around $70,000.

I am putting the numbers out here because; I have found many parents really do not grasp the cost of a university or college education in Canada (let alone the United States, where the undergraduate cost approaches $50,000 a year in many cases). I think because many parents paid minimal tuition and in many cases went to university in the city we grew up in, we don’t grasp the magnitude of today's tuition fees, even though the media publicizes it, accurately and often.

So how does one fund their children's post secondary education? Ignoring the small percentage of Canadians that have private incorporated businesses and make their children beneficiaries of a family trust and fund their education in whole or in part through dividends, there is no magical answer.

The first building block is utilizing your RESP. Under current rules, you can contribute a grant eligible $2,500 a year and the government will provide a grant of $500 for a total of $3,000 a year. The total lifetime contributions per child are $50,000 and the total lifetime grant is $7,200. Click here for an excellent discussion of RESPs by Mike Holman who wrote the book on RESPs.

Assume you have $2,500 per child available each year to fund their RESPs up to the $50,000 lifetime maximum contribution and the RESP receives the $7,200 maximum grant limit. If the RESP earns 5% a year, you could have upwards of $90,000 in each child’s RESP. This would go a long way towards covering most children’s university or college costs. However, the reality is that between covering day to day living costs, paying down mortgages, contributing to a TFSA or making RRSP payments, etc., many parents don’t have $2,500 per child to contribute, especially in the early years. But no matter what you can afford to contribute; the RESP should form the building block for funding your child’s education.

As parents, two alternative ways to provide the discipline to fund RESPs are: (1) use your monthly Universal Child Care Benefit cheques and/or (2) your tax refund or a portion of the refund.

With the huge wealth transfer taking place in Canada, some parents may receive an inheritance. In this situation you might consider opening a separate account with some of the money you inherited to supplement the RESP, or even open an account in your child’s name (There is no attribution if the child has capital gains in that account).

Where there is no potential inheritance and money is tight, attending university or college in your home town makes any undergraduate program at least somewhat affordable. To the extent you can send your child to another city, even for a year, I would suggest doing such. It is a tremendous opportunity assuming they partake in the university experience (that means activities other then just drinking).

Many parents, whether they have the money or not, feel their child should work to pay for some if not all of their university costs. Whether this is a necessity or your philosophy, this discussion should be held when your child starts high school so they are aware of your expectations and they can plan around those expectations.

Finally, there are various student loan programs to finance your child’s education; however, family income can sometimes disqualify the child.

As noted above, this blog contains no magical solutions. This blog is meant to try and make parents more cognizant of the true costs of university and college in Canada.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Introducing a Family Trust as a Shareholder in a Private Corporation

Two weeks ago I discussed using a holding company as a simple method to creditor proof excess corporate funds or other assets in a private corporation. In this blog I will discuss a “fancier” and far more complex transaction that can not only achieve creditor proofing, but potentially provides a means to income split with family members, potentially provides multiple access to the $750,000 capital gains exemption and finally, may provide a means to crystallize or "freeze" the income tax liability related to your company's shares at death.

For the purpose of this blog, I will  use the example of Starlet Yohansen who owns all the common shares of Movie Star Limited ("MSL"). The shares initially cost Starlet $1 and are now worth $3,000,000.

For Starlet to concurrently achieve all the objectives noted above, she would typically “freeze” the value of her  common shares in MSL. At the date of the “freeze”, Starlet would exchange her common shares for special preferred shares with a value equal to the value of the common shares exchanged, that being $3,000,000. Thus, at this point in time, there are no common shares and Starlet owns special shares worth $3,000,000. These special shares cannot increase in value, hence the term "freeze".

Any future growth in the value of MSL over the current value of $3,000,000 will accrue only to the new common shares that are issued as part of this reorganization. That growth will accrue directly, or indirectly through a family trust, to potentially Starlet's family members and/or a Holding company by having them subscribe for the new common shares issued in MSL (Starlet can also maintain some of the future growth if she subscribes for the new common shares or is included in the family trust). Often we see this strategy being used in succession planning when the owner-manager wishes to transfer ownership of their operating company to the next generation, but this strategy can be used without succession being the objective.

The beauty of the freeze is that Starlet's maximum income tax liability on her MSL shares has been established (unless she subscribes for more common shares). At Starlet's death, her income tax liability on her MSL shares will be equal to $3,000,000 times the applicable income tax rate at that time, likely around 23%. As Starlet knows the maximum income tax liability on her special shares she can plan to pay this liability by putting aside funds or by purchasing life insurance.

In addition, we often further reduce Starlet's  income tax liability by redeeming her frozen shares over time, which typically creates a current taxable dividend to Starlet, but also serves to reduce the value of the frozen shares by essentially the value of the dividend reported [ie: if Starlet redeems 500,000 shares that have a paid up capital and adjusted cost base of $1, she will have a deemed dividend of approximately $500,000 to report on her personal income tax return and her special shares are now only worth $2,500,000 ($3,000,000-$500,000 redeemed)]. Thus, if Starlet lives long enough, much if not all of her income tax liability can be eliminated prior to her death by redeeming her shares slowly over time.

If Starlet uses the Yohansen Family Trust to subscribe for the new common shares of MSL, the beneficiaries of the family trust would typically include Starlet, her spouse (although given Starlet's past history, we may want to leave her spouse out of the trust), her children and a Holding company. The inclusion of these beneficiaries can provide tax-effective income splitting on dividends received from MSL when the children are 18 years of age or older or when a spouse is in a lower income tax bracket (Starlet may have a trophy husband who does not have much income). The trust can also provide tax-effective income splitting on the sale of a business irregardless of the beneficiary’s age.

Generally, a family trust is discretionary. The trustees can tax effectively allocate the income received by the trust (i.e. dividends from MSL) to any or all of the beneficiaries including Starlet, so long as they are 18 years of age or older. A beneficiary who is 18 years of age or older and has no other sources of income can receive up to $37,500 in dividends tax-free. This strategy is a great way to help fund a child’s post-secondary school education (in addition to an RESP) or other expenses, while also lessening the family’s overall income tax liability.

If the shares of MSL are sold in the future, any sale proceeds in excess of the value of Starlet's original  frozen special preferred shares ($3,000,000 maximum) can be allocated to the beneficiaries of the trust. This may permit the utilization of the $750,000 capital gains exemption by each of these beneficiaries. A word to the wise though, any sales proceeds allocated to a beneficiary of the trust, including a minor child, will result in the money legally belonging to the child.

Finally, back to the original creditor proofing issue. The inclusion of a Holdco as a beneficiary of the trust would provide a means to transfer any excess funds in MSL as a tax-free via a dividend from MSL to Holdco thus creditor proofing the excess cash in MSL by moving it to Holdco.

I am sure there are very few readers still awake or with eyes not glazed over; but believe it or not, this type of reorganization has been simplified greatly for discussion purposes. There are several pitfalls along the way and in the future that must be avoided in order to successfully achieve the objectives noted at the beginning of this blog. If you are contemplating undertaking such a transaction, you must consult your accountant and lawyer to ensure that the transaction makes sense given your personal situation and that no details are missed in carrying out the finer points of the reorganization.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the material is time sensitive and subject to changes in legislation or law.