Your children likely earn little to no income while they are minors. Wouldn’t it be nice to have some of your income get taxed in their hands instead of yours? While the government has shut down a lot of tax planning strategies involving minor children (i.e., children under 18 years of age), there are still some available strategies available. The one strategy we discuss below will allow you to diversify your investment portfolio while teaching your kids to invest.

Income Splitting & Attribution Rules

The income tax act has rules to prevent you from splitting income with your spouse and minor kids. Here’s a quick example:

• Suppose Ross and Rachel are husband and wife.
• Ross is in a higher tax bracket compared to Rachel.
• Ross gifts $1,000 to Rachel.
• Rachel takes this $1,000 and invests this money in Apple shares. A year later, the apple shares grew to $3,000. Rachel sells the shares and makes a $2,000 capital gain.

The income tax rules will “attribute” the $2,000 capital gain back to Ross so that Ross is taxed on it instead of Rachel. This rule shuts down Ross’s intention to income split with Rachel.

Income Splitting Property Income

The income tax act has rules designed to prevent income splitting between you, your spouse (or common-law partner), and non-arm’s-length minors (including nieces and nephews). We call these rules the “Attribution Rules.”

Although there are some exceptions, these rules generally apply where you transfer or loan money to or for the benefit of your spouse, kids, nieces or nephew. These rules only apply to specific types of investment income: interest, dividends, rents, and royalties. We call these types of income “property income.” These rules make it difficult to split property income with your spouse or minor kids (including nieces and nephews) by giving them money to invest.

You may be wondering why Ross in the above example got hit with the “Attribution Rule” since Rachel earned “capital gains” and not “property income.” We explain this in the section below.

Income Splitting Capital Gains

Capital gains are not considered property income. But, the income tax act has similar rules designed to prevent capital gain splitting between you and your spouse (or common-law partner). No parallel rule attributes capital gains on property loaned or transferred to your minor kids (including nieces and nephews). And here’s where the planning begins!

This means that you can transfer money to your minor children and have them invest in capital gains-producing investments. The capital gains on these investments do not attribute back to you.

Note that while capital gains are generally not subject to attribution, any property income (interest, dividends, rents, etc.) arising from the invested proceeds will be attributed back to you (see the previous heading).

Tax Planning Tips with Minor Children

Since capital gains do not attribute back to parents, you can give your kids money to invest in investments that produce capital gains. This could include growth shares. You can use this as a strategy to hold some of your “risky” growth shares under your children’s accounts. This could prove to be a tax-effective way to fund your children’s expenses (private school, fitness activities, etc.) and teach them how to invest their money.

Here’s a quick example:

• Suppose Mary is in the highest tax bracket and has a son, Jimmy, 16 years old.
• Jimmy is interested in learning about finances and investing.
• To save taxes while teaching Jimmy to invest, Mary gifts $1,000 to Jimmy.
• Mary helps Jimmy invest the $1,000 in growth shares.
• In a year, the $1,000 investment grows to $5,000.
• Jimmy will be subject to tax on the $4,000 gain. Because Jimmy has no other income, he will pay no tax on this gain.

The income tax rules will not “attribute” the $4,000 capital gain back to Mary. This strategy allowed Mary to save over $1,000 in taxes since her marginal tax rate on capital gains would be around 27% (Ontario, 2022).

Income Splitting With Adult Children

Note how the “Attribution Rules” above only targeted spouses and minor children. Income splitting with adult children is a tax-effective way of giving your adult kids money. They can use the income earned to pay for things like their post-secondary education or a downpayment on their home. The benefit is that the tax is calculated using their lower tax brackets.

Importance of Working with a Tax Specialist

The above is a good strategy. But the devil is in the detail. For these strategies to work, you need to implement these transactions properly from a tax and legal perspective. This is why you should hire tax specialists like LRK Tax who have experience implementing these types of structures.