Gift-giving season is nigh. But the tax department’s attribution rules complicate the matter of giving securities to your children and grandchildren.
Always keep things in perspective when you tax plan. Once you start agonizing over every dollar or delving too deeply into the Income Tax Act, planning becomes long and hard. Don’t worry about items that make little difference to your eventual tax bill.
We were reminded of this pitfall by a friend. He wanted to give some shares to his grandchildren as a gift, but was worried about the attribution rules. Our friend was concerned that he might have to keep track of and declare all the future income from these shares. If there was going to be a tax problem, he said he’d give the grandchildren something else.
We first asked our friend whether these were large gifts. If they amounted to, say, several hundred thousand dollars, the tax department may very well view them as a form of income splitting and add back the dividends (or interest) to our friend’s taxable income. By contrast, a tax auditor would almost certainly view small gifts and their resulting income as immaterial. So while in theory the attribution rules may apply, it’s unlikely that an auditor would invoke them to reassess the grandchildren’s income.
Reinvested dividends are exempt
Put simply, the government developed attribution rules to prevent blatant income splitting, which diverts income from a person in a high tax bracket to a close relative earning little. Since the redirected earnings attract few taxes, the family cuts its tax bill.
To close such loopholes, the government introduced rules attributing earnings back to the true income earner. (Retirees, however, can do some income splitting.) Just remember the government designed these attribution rules for big amounts, not for every small loan or gift within the family.
Take the case of our friend giving shares to his grandchildren. According to the law, when someone transfers or loans property to a child under 18, the income gets attributed back to the original owner. However, there’s no attribution of capital gains. In theory, our friend should monitor the dividends and declare them. In fact, though, this rule, if strictly enforced, would create an administrative nightmare. Everybody who gives a child some shares on a birthday or at Christmas would need to start keeping extra records. This is an excellent example of when not to delve too deeply into the Income Tax Act.
Capital gains by a minor aren’t attributable
Of course, if our friend is concerned about the need to report properly or wants to give securities on a regular basis so that meaningful amounts become involved, he should consider choosing non-income-bearing investments. Since capital gains by a minor aren’t attributable it would make sense to select growth stocks paying little or no dividends.
Keep in mind, too, that if you plan to give your grandchildren securities, ownership passes at market value. You must take unrealized profits or losses into your taxable income. Only future capital gains belong to the grandchild. So it’s best to buy the securities just before transferring them to the minor.
The income from the securities, though, remains the property of the grandchildren, even if it’s attributed to you for tax purposes. So with the reinvestment of those dividends, income from this money is no longer attributable.
Attribution remains a consideration in tax planning, but not an overriding one for most people. It certainly should not interfere with plans to give a few securities to your grandchildren.
When to set up a trust
Minors lack the legal ability to sell securities. As a result, stocks or bonds registered in the child’s name could become locked-in for years.
Provided you stick with high-quality companies, the locked-in situation is manageable.
We suggest setting up a simple trust if you regularly give your children or grandchildren securities. Name the child as the beneficiary and yourself as trustee. You can then sell the securities and have the trust pay any dividend or interest to the child, though technically it’s your taxable income. The attribution rules still apply to trusts.
This is an edited version of an article that was originally published for subscribers in the October 23, 2020, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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