Review your family trust’s tax situation
Many individuals set up inter-vivos or family trusts to split income and better manage family finances. Inter-vivos trusts are taxed as individuals, but with all income subject to tax at the top marginal rate if the trust was set up after 1971. All inter-vivos trusts must have a December 31st year-end, and the tax return (called a T3 return) is due 90 days after year-end — by March 31, 2011 for 2010.
A trust can deduct from its income any amounts that were paid or became payable to beneficiaries in the year. This income is then taxed in the hands of the beneficiaries to whom it was allocated. This is usually advisable where the beneficiaries are family members who will be taxed at lower marginal rates. Minor children are taxed at top personal rates on certain types of income distributed from a trust. For more information on this income splitting tax, read our Income Splitting bulletin. Also, the CRA has become more active auditing family trust documentation, so you should read “Family Trust Audits Highlight Need for Proper Trust Records” in the 2010‑03 edition of the Tax Factor.
In the past, income of the trust could be taxed in the beneficiaries’ hands even though it was not paid or payable to them. If the trust had been structured to allow this type of tax planning, the trustees and the beneficiaries could jointly make a “preferred beneficiary election” (PBE) to have the income taxed in the beneficiaries’ hands even though it was retained in the trust. The ability to make PBEs is now only available for beneficiaries who are disabled.
Ensure that you review the tax status of your family trust with your BDO advisor before year-end to determine the amount of income earned in the trust and the way it will be taxed.
If a PBE is not available, you must ensure that the income is either paid or payable to the appropriate beneficiaries on or before December 31st. Otherwise, the income will be taxable in the trust at top marginal rates.
Another point to keep in mind is that certain trusts are deemed to dispose of capital property every 21 years. There are strategies which you can use to minimize the impact of these rules. Consult your BDO advisor.
Make tax instalments by the required due dates to avoid non-deductible interest and penalties
If your total tax exceeds your tax deducted at source by more than $3,000 ($1,800 in Québec) for 2011 and for either 2010 or 2009, you may be required to make quarterly tax instalments. The deadlines for instalments are the 15th of March, June, September and December. If you fail to make the payments, or pay less than the required minimum, you’ll be charged interest and possibly penalties. Interest and penalties on tax instalments are non-deductible.
Calculating the appropriate instalments can be difficult. Generally, you can base your payments on either the current or previous year’s tax, whichever is lower. However, the CRA does issue notices to taxpayers advising them of the amounts. The March and June amounts are based on the second preceding year, with the September and December amounts based on the previous year. The Ministère du Revenu du Québec also issues instalment notices to taxpayers. As long as the amounts in the notices are paid on time, instalment interest will not be charged.
If your income has increased over the last few years, the CRA’s method should be beneficial. However, the CRA may not always have the most current information and, in some situations, one of the other methods may be more advantageous for you. If you’re uncertain as to the amounts appearing on the notices, contact your BDO advisor for assistance in determining your appropriate instalment amounts.
Contribute to your RESP
You can start saving now for your children’s education by making contributions to a Registered Education Savings Plan (RESP). Earnings on RESP investments accumulate tax-free and are generally taxed in your child’s hands when withdrawn from their plan. With a lower marginal tax rate, your child should pay much less tax on the income than you would pay.
There is no longer an annual RESP contribution limit, however, there is a lifetime RESP contribution limit of $50,000. When you contribute money to an RESP, the federal government will deposit an additional amount – the Canada Education Savings Grant (CESG) – equal to 20% of your contribution up to certain limits. The maximum CESG each year is $500 (equal to 20% of a contribution of $2,500) and the lifetime CESG limit is $7,200. Also, higher CESG rates apply to certain contributions made by low and middle-income families.
If you fail to make a contribution in a year, the unused “CESG room” will be carried forward. But your ability to utilize CESG room in future years will be limited. Consequently, if you are considering an RESP contribution in the near future, you should try to make a contribution before year-end.
Another CESG rule is important to consider as part of your year-end tax planning. The CESG can be restricted during the years the beneficiary turns 16 and 17. A CESG will only be allowed if:
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contributions to all RESPs for the child have totaled at least $2,000 before the year the child turned 16, or
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contributions of at least $100 per year were made for the benefit of the child during any four years prior to the year the child turns 16.
Therefore, you may need to make an RESP contribution this year so that your child’s RESP is eligible for a CESG in future years.
The 2008 federal budget extended certain time limits with respect to RESPs, applicable for 2008 and subsequent taxation years, as follows:
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the number of years you can contribute to an RESP has been extended from 21 to 31 years (25 to 35 years for disabled beneficiaries),
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the deadline for terminating an RESP has been extended from the end of the year that includes the 25th anniversary of the opening of the plan to the 35th anniversary (30th anniversary to the 40th anniversary for disabled beneficiaries), and
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the contribution age limit for a beneficiary of a family plan has been increased from 21 to 31 years.
The recent changes to RESPs have made them more advantageous. Although the elimination of the annual RESP contribution limit means you may have more decisions to make about how much to contribute each year, your BDO advisor can assist if you have questions. With the high cost of post-secondary education, be sure to consider this savings vehicle as part of your year-end tax planning.
We hope you find these tax planning ideas useful. Many of them can be easily implemented with little or no cost or administration. Others are more complicated and will require professional advice. If you need assistance with your year-end tax planning, contact your BDO advisor.
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