Understanding the KiddieTax, Part 1

On January 1^st, 2000 the “Kiddie Tax” came into the Canadian law books.  The main purpose of introducing this new tax was to deter the many Canadians from income splitting with their kids.  Before January 1^st, 2000 many Canadians would simply structure their affairs so investment income was realized in their kids hands, thus having a much lower tax rate (many times no tax was realized).

This “Kiddie Tax” applies to certain types of income that is structured in ways so the minor child receives the income.  We are speaking of kids under 18 that belong to Canadian resident parents.  This “Kiddie Tax” makes it so that instead of the minor child paying income tax at a lower rate (or no tax at all), they end up paying the highest tax rate possible!  Planning around this rule is a must when planning income splitting with your kids.  Of course the minors may not be able to afford to pay this tax, so the parents end up being liable for the tax as the ultimate liability for “Kiddie Tax” rests with the parents.

The most common type of income to which the “Kiddie Tax” applies is dividend income from corporations and trusts.  Before the new “Kiddie Tax” it was regularly part of the plan to structure affairs using a trust that receives dividends and then would flow it out to the minors which would pay little to no tax.  Some structures even allowed minors to receive dividends directly from a corporation of which they were a specified class shareholder.  Before the “Kiddie Tax” this simple plan was very effective in saving tax as the child could use up their personal tax credits and pay tax in much lower tax brackets.  In fact many times there was no tax to pay if the income was kept under certain levels.

We’ll continue our blog series on the Kiddie Tax on Thursday. Please check back!