Why not help your clients kick-start a year of tax savings by recommending an income-splitting prescribed rate loan strategy so they can split their investment income with their children in 2015?
Under the Income Tax Act (ITA), if your clients simply lend their kids money to invest and don’t charge interest on that loan, any interest income or dividends earned on those funds is attributed back to your clients and taxed at their marginal tax rate.
On the other hand, as long as your client charges the prescribed interest rate, any income they earn above that rate can be taxed in their child’s hands. If your client’s child has minimal or no income, the tax payable on any excess return earned above the prescribed rate charged on the loan can be reduced substantially; in many cases, it may be eliminated altogether because of the basic personal amount, which is $11,327 in 2015.
There is no better time than now to help your clients set up such a loan because the prescribed rate, which is calculated based on the average yield of 90-day T-bills sold during the first month of the previous quarter, has been fixed at 1% until at least March 31, 2015. That’s the lowest rate it’s ever been and it ever will be because the rate is rounded up to the nearest whole percentage point.
The best part of executing such a loan before March 31 is that the rate can be fixed for the duration of the loan. In other words, even if the prescribed rate goes up over the next few years, your clients can still use the 1% rate for as long as the loan is outstanding because the ITA only specifies that they charge the rate at the time the loan was originally extended. That’s why, in practice, many such loans have no specific term on them and are simply payable “on demand.”
The only obligation is for your client’s child to pay the client the 1% interest on the loan by Jan. 30 of the following year (i.e. Jan. 30, 2016). The interest paid is deductible to your client’s child and reduces the taxable income from the investment, but it’s taxable to your client. The net benefit, therefore, is simply the tax savings realized annually from having any excess returns above 1% taxed in your client’s child’s name, instead of your client’s.
Practically, many parents who set up such loans do so by lending the funds to a family trust in which the child is merely the beneficiary and can’t exercise control over the funds being invested.