Among the many things we do for our clients, one is finding ways they can legally pay less taxes.
There’s a new piece of legislation coming down the pipeline which could dramatically affect tax planning strategies for some business owners if it becomes law.
For business owners with children in their late teens, one of those ways was to issue the children shares that paid dividends.
Why? If a business owner parent pays for tuition, room and board for their child, they’re using money that’s already been taxed. If they sell their children shares of the company that pay dividends, the children who are not likely making much money can use those funds to cover their education expenses.
Clearly, we are not the only firm who has been using this strategy. The graph above illustrates three different time periods, showing private company dividends being paid out. Normally, you’d expect this graph to be a bell curve. Owners take more dividends as they progress through life, and earn more money in their company. However, this tax planning strategy of paying money to tuition-paying kids causes that odd bump left of the dotted line in the 18-21 year old range that wouldn’t really be expected for any other reason.
This bump suggests that people who were 21 earned about $200 million in private company dividends, while people who are 26 earned notably less.
The proposed legislation says that if you’re paying a dividend to someone under 24, you have to explain what they’re doing to earn that dividend. If they’re investing in their own start-up, they may be able to justify getting dividends. One of the challenges with wording this legislation is that it has to be interpreted in such a way that you don’t prohibit young adults from being successful while trying to close this tax loophole.
In theory, it’s possible for an 18 year old to have a great idea that makes a lot of money – in that case, the dividends are legitimate.
The potential implementation date is the 2018 tax year and the legislation is currently in draft and going through review. If you’re a business owner with children between 16 and 24, you should be checking to see if this is going to be an issue. We’re reaching out to our clients who are doing it as it’s a big tax planning opportunity that may go poof.
Tax laws change constantly – if you’re experiencing life changes such as a child going to university, please get in touch if you would like to discuss your personal situation.