Parents and grandparents often want to give generously to their loved ones. Unfortunately, good intentions are not enough. As legal professionals, we must provide pragmatic and effectual consultation. Otherwise, a gift could result in unintended consequences for both the client and the lawyer. This article discusses methods of gift giving and potential traps.
Giving away the store to save tax dollars
Health care is very expensive, and the public system does not cover everything. There can be many unforeseen circumstances in the course of life. Only assets that are explicitly not needed during the client's lifetime ought to be considered for gifts to loved ones. Don't be cajoled into letting the tax and probate issues be the primary concern; they are not. The first priority is the client's benefit.
Big Tax Bite Surprise
For tax purposes, non-cash property gifted is treated as having been sold for fair market value. This can cause immediate capital gains tax liability. For example, if your client gives a cottage, shares in a company, or family jewelry to a loved one, count on the client paying tax for the same value as if the property were sold to a stranger for its fair price.
Gifts to children and grandchildren
If your client gives money to a family member who is a minor, and that money earns interest, the client will be taxed on the interest earned. If the funds earn a capital gain, the client does not have to pay the tax, but the minor will.
A substantial gift to a minor ought to be left in a properly structured trust with a capable trustee(s) to oversee the funds until the child reaches an appropriate age and takes over control. If desired, a trust may also permit the reversal of the typical arrangement, to return the funds to the client or their spouse.
Gifts to adult children are subject to different rules. When clients give money to adult children who are at or near the top marginal rate of tax, little or nothing is saved unless the children spend the funds immediately. For example, using the funds to pay for RRSPs or to pay down a mortgage is probably tax efficient for both parties. On the other hand, there are no tax savings if the adult children invest the funds and earn investment income at the top rate.
When making a gift, Registered Education Savings Plans might also be considered. Unlike with RRSPs, the contribution is not tax deductible. However, the government tops up the contribution by 20%, to a maximum of $500 per year per child. The government top-up has a lifetime maximum of $7,200. Alternatively, lump-sum contributions can be made up to the lifetime maximum of $50,000. Funds earn income free of tax until withdrawn for post-secondary education, at which time the income is taxable in the child's or grandchild's hands. There are many different plan alternatives. The classic scholarship trusts are more restrictive, but they may offer higher benefits if the child pursues higher education. You must review the alternative plans and consider where the funds go if the child does not pursue post-secondary education. In some cases, the accumulated income is lost.
Family Loan Faults
Loans to family members may cause unexpected taxes for your clients and their children:
- When a client makes a loan to a minor or to a non-arm's-length adult and the proceeds earn property income, some or all of the income is attributed back to the client for tax purposes. Business income and capital gains are excluded.
- If a loan made to a child and used to earn property or business income is forgiven in the client's lifetime, the amount forgiven may be included in the income of that child. This will lead to an unnecessarily large tax bill. However this does not apply to loans forgiven in a will.
- If a loan has been made to a child's corporation, it is better to assign the loan to the child than to forgive the loan. An assignment will permit the child to extract from the company an equivalent amount of funds without paying taxes that would otherwise be payable.
It is important to make sure all issues have been considered before a client makes important gifts or loans to family members. Ensure their good intentions and generosity have the intended effect.
Guy Desmarais, B. Com., LL. B. TEP. Guy is a partner in Collins Barrow's Sudbury-Nipissing member firm. He can be reached at gudesmarais@collinsbarrow.com, or by telephone at 705-560-2056.