Kiddie Tax is No Child’s Play

September 23rd, 2014 by

In this week’s iteration of the tax blog, we explore the oft-cited, yet somewhat-less-oft understood, “kiddie tax.” While the terminology may sound more endearing than some other taxes, getting caught by the kiddie tax is no fun, and can result in some serious tax consequences. It is thus important to know what it is, and how to avoid getting caught by it.

Before I get into the technicalities of the tax, let’s take a step back. In the 1990’s (when I was still considered a ‘kiddie’), one of the most prevalent ways of splitting income was through the use of corporations and the issuance of shares in said corporation to an owner’s minor children. The corporation would issue dividends to the minor shareholders who, because they are minors and most likely have no other income, would pay considerably less tax than if the dividends were issued to their parents. However, like the nineties themselves, the days of income splitting in this manner ended in 2000 with the introduction of s.120.4 of the Income Tax Act (the “Act”).

S.120.4, known technically as the “Tax on Split Income” provision, was aimed at eliminating the ability of high-income individuals to shift portions of their income to their no-income children through the use of dividends. Under s.120.4 if a minor child (under 18) with a parent resident in Canada receives dividends from a privately controlled corporation, these dividends will be taxed at the highest marginal tax rate – 29%. As well, any capital gains realized on the disposition of the shares to non-arm’s length parties will be taxable at this rate. And, while the minor could avail themselves of the divided tax credit, s.120.4 denies them the ability to use any other credit, even the basic personal credit, to reduce the amount owing under s.120.4.

In 2014, s.120.4 was amended to expand the ambit of what income would be caught by the tax. The new s.120.4(1) now includes amounts that  “can reasonably be considered to be income derived from the provision of property or services by a partnership or trust to, or in support of, a business.” In plain English, the definition now includes business and rental income derived from third parties which have been paid to the minor.

While 29% tax is a tough pill to swallow, there are ways of obviating s.120.4, most commonly in the case of adult children. If you or a member of your family is facing liability under s.120.4, please contact one of our skilled tax lawyers, who will be happy to discuss the issue with you.

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