Tax Question:
How can I pay for my children’s university tuition with dividends and not lose the tuition credits?
Facts:
If your children are shareholders in your company, it may be beneficial to have them receive dividends and use those dividends to pay tuition. The reason dividends are used is that if we used salaries, we would find that they must be “reasonable” for the work performed. This could limit the number of salaries as the children are likely too busy at university to show up at your business and work. There is no reasonableness test for dividends; however, there is a technical tax challenge to using dividends instead of salaries. Dividends receive dividend tax credits and these tax credits can cause you or your children to lose the tuition credits as you cannot “double-dip”. The result of losing the tuition tax credit is that you pay a hidden tax on the tuition. Any tax savings from using dividends is lost.
With the rising costs of tuition and living expenses, it is getting more and more expensive to send your children to university. If you own your own business, it is beneficial to pay your children wages through the company to cover the cost of school. If the children are shareholders, this allows the company to pay them dividends at the discretion of the voting shareholders, which are usually the parents. Therefore, there is no cap on the dividends like there is for wages.
The trick with paying dividends is when the children prepare their personal income tax returns. You want to be able to use all their dividend tax credits and be able to carry forward their unused tuition tax credits to another year or transfer them to the parent. Dividends are grossed up for tax purposes, which increases the taxable income and then credit is applied to reduce the taxes. However, the dividend credit is applied after all the other credits are used. As a result, the tuition credit will be used first. Since the grossed-up income from the dividend usually uses up all the tuition credit, there is none available to be carried forward to future years or transferred to a parent. The dividend credit is applied last and may not be needed since the tuition credit decreased the income to Nil. As the dividend credit cannot create a refund and cannot be carried forward to future years, it is wasted.
Therefore, we suggest giving a large dividend in one year rather than a smaller dividend each year the child is in university. If one large dividend is issued to cover two or three years of tuition and living expenses, the credits are used to reduce the taxes owing in the one year that the dividends are issued. That means that in years two and three, the child will report no income and be able to carry forward or transfer their unused tuition credits. The company’s cash flows will not be affected by the large dividends as the full amounts do not have to be paid. They can be put into the children’s shareholder loan accounts and drawn down over the two or three years as needed.
If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.
Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.
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