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Fund your kid's schooling -- with loan from your business

School is about to begin. My son, Winston, and daughter, Sarah, will be in grade one and junior kindergarten, respectively.

This week I was reminiscing about my own grade school days as I found one of my old report cards. Language arts and music were not my strong subjects in grade two.

My language arts teacher wrote: "The dawn of legibility in Timmy's handwriting reveals his utter incapacity to spell."

A little further down, my music teacher wrote: "Timmy contributes very nicely to the group singing by helpful listening."

It's a miracle that I eventually went to university. For some parents, it might take a miracle to pay for university.

I want to talk to those of you who are business owners today. A loan from your corporation to your child can really help to pay for that education.

The strategy

One of the most common strategies used by business owners in an attempt to access the cash that may be in a company is the good old shareholder loan. As a shareholder, you have the ability to borrow money from your own company.

The problem? Canadian tax law is designed to limit your ability as a shareholder to take money out of your company on a tax-free basis. And subsection 15(2) of our tax law deals specifically with loans to shareholders.

The general rule is this: If you borrow money from your company, the amount is taxed as income, unless you meet one of the very few exceptions spelled out in our tax law. Now, a loan from your company to a child of yours to pay for an education is not one of those exceptions. The bottom line? A loan to your child to pay for an education will be taxable in the hands of your child in the year of the loan.

Is this so terrible? Not necessarily. You see, an adult child (age 18 or older) who receives a loan and has little or no other income in the year will pay little or no tax on the loan amount included in income thanks to the basic personal tax credit, tuition and education tax credits, and any other credits he may have available. So, the tax rules have little or no bite in this case.

But get this: After your child graduates and is working full time, he can repay that loan to your company, and will receive a tax deduction for those repayments at that time. That's right, subsection 20(1)(j) of Canadian tax law will allow a deduction when the loan is paid back. And let's face it, that deduction will come at a time when your child will be looking for tax relief.

The details

Keep three things in mind if you're going to implement this strategy.

First, your child must be an adult for the idea to work. If she has not yet reached age 18, special rules in subsection 120.4(2) of our tax law will cause your child to pay tax at the highest rate on that loan, with no offsetting tax credits.

Second, this is a loan from your company, so the amount will not be deductible by the company, unlike salary or wages paid to your child.

Finally, your child may face a taxable interest benefit on the outstanding loan each year at the prescribed rate (currently just 2 per cent). Still, a potentially tax-free payment made to help with your child's education, plus a deduction for your child when (and if) the loan is repaid. It's a pretty good deal.

tcestnick@aic.com



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