Employee Profit Sharing Plans (EPSP’s), Part 3 of 4

Here is the 3^rd part of our EPSP blog series.  In this 3^rd part, we focus on the consultations made in connection with some proposals to change EPSP rules.

If the rules change as we think they may, this could really put a damper on this loophole for many business owners.  Here is the summary of the consultation that was published.

1. Eligibility to participate in an EPSP

The Income Tax Act contains provisions that limit the ability of employees who do not deal at arm’s length with their employer to enter into certain compensation arrangements with their employer. For example:

• To be accepted for registration, a deferred profit sharing plan must exclude persons related to the employer and specified shareholders from participating in the plan; and
• To qualify for a deduction, employees who exercise stock options must deal at arm’s length with the employer.

With the proposed changes, EPSP provisions may include similar restrictions on the participation of employees.

Is there a specific rationale for allowing non-arm’s length employees to participate in an EPSP?

What would be the impact on your business or clients if employees who do not deal at arm’s length with the employer, such as related persons, were excluded as eligible EPSP beneficiaries?

2. Role of Minor Children

The Income Tax Act contains provisions to limit income-splitting techniques that seek to shift certain types of income (e.g., certain capital gains, taxable dividends, income from partnerships) from a higher-income individual to a lower-income minor. Under the tax on split income provisions, for example, income received by minor children is taxed at the highest federal marginal income tax rate (29 per cent). In Budget 2011, the Government extended the tax on split income to certain capital gains on shares of most unlisted corporations. EPSP allocations are not subject to these provisions currently, however the revision could change this.

Is there a specific rationale for excluding EPSP allocations from the tax on split income provisions?

What would be the impact on your business or clients if EPSP allocations to minor children were subject to the tax on split income?

There are 3 items left on the summary of the consultation – Limitations on contributions, Withholding Requirements and Additional Questions.  We will take a look at these on the next part of this series. 

Understanding the KiddieTax, Part 3

The 2011 Federal Budget has introduced a new legislation whereby after March 22, 2011 such capital gains will now be subject to the “Kiddie Tax.”  However, other capital gains realized by a minor (for example, from a publicly traded portfolio of assets or shares of a private corporation disposed of to an arm’s length person) will continue to not be subject to the “Kiddie Tax.”  As such, capital gains realized and taxable in the hands of a minor either directly or indirectly is still a common and effective income splitting tool in many cases.

Also, partnerships and trusts that provide services to arm’s length parties are also not subject to the “Kiddie Tax”.  Let’s say that a mom, dad, the kids and a trust all form a partnership.  The partnership’s purpose is to sell food and drink (something a whole family could do).  When the partnership receives profits it can allocate these profits to the partners, which include the minors.  Typically no “Kiddie Tax” would be applied in this instance.

There are other ways to avoid this “Kiddie Tax” as well, such as simply paying the minor for work rendered.  When your children work for you it can be legitimately be their income and taxed in their hands at a much lower rate.

The “Kiddie Tax” definitely makes the family income splitting more difficult, however there are ways to effectively split income.  Careful planning with professionals must be done before implementing any plan.  On top of the current rules making it more complex, the changes in income tax laws each year make it even more difficult.  Thus, if you are looking for ways to income split, don’t hesitate to contact us as we would be glad to plan with you!  Our professionals along with our strategic alliance of tax lawyers can help you plan for all types of tax savings!

This concludes are blog series on the Kiddie Tax. I hope you now have a better understanding of its rules and how it can impact your tax saving strategies!