My neighbor tells me that he pays his adult children out of his business corporation to fund their costs and expenses while they attend university, and saves a lot on tax compared to what he would pay if he personally funded their expenses. How do I set up my business corporation to do this?
The strategy used by your neighbor likely involves the issue of “dividend sprinkling” shares to his children. It works only with payments made to children over the age of 18 years. In essence, the strategy works to shift income from the high-tax rate paying parent, to the low-tax rate paying child. In many situations the entire dividend is received by the child free from additional tax. The strategy also works between spouses, shifting income from the high tax rate paying spouse to the lower tax rate paying spouse.
The attributes of “dividend sprinkling” shares typically include: a discretionary dividend right (meaning that you determine in any year the amount, if any, of the dividend paid); the right to redemption by the corporation for a fixed amount – often $10 (meaning that if you no longer wish to have the child own shares, the corporation has the legal right to cancel them for a nominal payment); and are non-voting (meaning you are not giving your child a say in the operation of your business). When shares are issued by an existing corporation, it is advisable that a share freeze be completed prior to their issuance. The “share freeze” is a technique which locks in the current value of a corporation to the existing shareholders with dividends being paid out of increases in value or income of the corporation.
There are significant tax and legal complexities and traps associated with setting up and using a dividend sprinkling share structure – including the risk if not properly structured and implemented that amounts paid on the dividend sprinkling shares will be attributed to someone other than the child. Legal and accounting advice should be obtained.