Tax returns for kids
Should Junior file a tax return? There are a number of situations in which you are required to file a tax return, the main one being if you have to pay tax. Since most children earn less than the basic personal amount, which was $9,600 in 2008, they don't owe tax. So, why would you file a tax return for a minor?
One reason is to report income the child may have earned from casual, part-time or summer employment. Though it's likely no tax would be owing on such income due to the basic personal credit, reporting such "earned income" will generate RRSP contribution room (equal to 18% of the amount earned). This room can be carried forward indefinitely by the child.
Filing a tax return early in life can bolster the amount that can later be socked away in an RRSP.
The recent introduction of the tax-free savings account (TFSA) makes this strategy even more palatable. Often, young people starting their first jobs, and in the lowest tax bracket, are discouraged from making RRSP contributions until they get into a higher tax bracket where the deduction is worth more.
The new TFSA could allow a young person in the lowest tax bracket to save excess funds in a TFSA for a number of years, while slowly building up RRSP contribution room until she earns and reports employment income.
When the individual, perhaps now in her late 20s or 30s, enters into a higher tax bracket in which RRSPs make more sense, she could simply transfer the TFSA funds into an RRSP on a tax-free basis and claim an RRSP deduction at the new, higher bracket.
The icing on the cake is that the TFSA transfer into the RRSP will re-establish TFSA contribution room in the next calendar year. The TFSA room can be carried forward and used in any future year to make a contribution.
It also makes sense to file a tax return for a child when you've been investing on the child's behalf and want to demonstrate a track record of tax compliance with the CRA.
Many parents and grandparents often use in-trust accounts to invest in equities directly (or indirectly through equity mutual funds), relying on the fact that if only capital gains are generated those gains will be taxed in the hands of the child or grandchild without worrying about the attribution rules.
The attribution rules attempt to prevent income splitting among family members by attributing investment income earned by a child back to the contributing parent. While both interest and dividend income are subject to attribution when funds are invested on behalf of a minor, there is an exception for capital gains.
By reporting any such gains on the child's tax return, even though they may not be taxable due to the basic personal credit, you are demonstrating to the CRA that such gains do indeed belong to the child and should not be taxed in the parents' hands.