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Earnings on Registered Education Savings Plan investments accumulate tax-free and are generally taxed in your child’s hands when withdrawn from their plan |
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 31 year-end, and the tax return (called a T3 return) is due 90 days after year-end — by March 30, 2012 for 2011.
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 31. 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. As well, read our recent article “Remember the 21 Year Deemed Disposition Rule for Trusts” in the 2011-03 edition of the Tax Factor.
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 2012 and for either 2011 or 2010, 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.
For more information, read our tax bulletin titled Failure to Pay Instalments Can be Costly.
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.
While there is no annual RESP contribution limit, 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, an additional CESG is available 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:
- Contributions to all RESPs for the child have totalled at least $2,000 before the year the child turned 16, or
- 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.
With the high cost of post-secondary education, be sure to consider this savings vehicle as part of your year-end tax planning. For more information on RESPs, read our tax bulletin RESPs: Saving for Your Child’s Education. Your BDO advisor can assist if you have questions.
U.S. citizens
As a final note, these tax planning suggestions are for Canadian tax purposes. If you are a U.S. citizen living in Canada, you will want to consider the impact of these planning suggestions on your U.S. taxes to ensure that they do not cause adverse U.S. tax consequences before implementing. For more information, read our tax bulletin Tax Consequences for U.S. Persons in Canada. Your BDO advisor can assist if you have questions.
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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