Get repaid for funding a child’s education

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Peggy and Assaf’s 17-year-old son, Samir, plays defense for a hockey team in Belleville, Ont. He just earned a partial athletic scholarship to the University of Michigan to play for the Wolverines, a Division 1 NCAA team. The scholarship covers his four-year tuition and living expenses, except $44,000 ($11,000 per year). Peggy and Assaf will fund the shortfall, but Samir could make much more if he’s drafted by a major league, and they’d like to be repaid. They’ve decided to create an in-trust account for his education and living costs. How should it be structured? What alternatives exist?

The experts

Maxwell Gotlieb

Partner, Cassels Brock & Blackwell LLP

Kaylie Handler

Associate, Goddard Gamage Stephens LLP

Floyd Gradley

Estate and trust lawyer, Tax and Estate Planning Team, Mackenzie Investments

Who do you call?

Estate and trust lawyers, and tax specialists.

What they say

Maxwell Gotlieb:

All my kids went to the U.S. for graduate school. To get a student visa, the school and the U.S. government will require proof that you can cover tuition and living expenses. In some cases, they’ll want to see money in a bank account, or you can get a letter from your financial institution guaranteeing your ability to pay.

The simplest thing for Assaf and Peggy to do is open a bank account, deposit $44,000, and name it “Assaf and Peggy in-trust for Samir.” The parents would be the only signing parties. If they intended to loan the funds to Samir rather than gifting them, the parents might draw up a promissory note. Since Samir is under the age of majority, any promissory note that he’d sign would be unenforceable [so they may want to wait until he turns 18]. The note should indicate whether there will be interest charged on the loan. If the parents are devout Muslims, [they should know] that under Sharia law, interest cannot be charged on the loan.

Read: Parents want ROI from education spending

If funds are gifted to Samir, some types of income earned (such as interest and dividends) while he is under the age of majority may be attributed back to the parents for Canadian tax purposes.

Rather than investing the funds in interest-bearing securities, for example, the parents can buy publicly traded securities with the money in the account. If they incur capital gains, the amounts will, generally, not be attributed back to the parents for tax purposes.

The parents might have Samir sign a promissory note and a General Security Agreement (registered in the U.S. under the Uniform Commercial Code) if they are loaning funds to him. Effectively, Samir would be charging and assigning his rights to future contracts to his parents, to the extent of his indebtedness.

Read: Parents to cover half of university costs for kids

If the parents are truly optimistic about Samir’s future and they anticipate contributing substantial money to him, they and Samir could enter into a limited partnership arrangement. Samir would provide his athletic services through the LP, and the parents could share in an agreed percentage of his future income for an agreed period of time.

Expenses incurred to earn income, and funded by the parents as limited partners, might be tax deductible (although CRA may not agree, since there needs to be a reasonable expectation of profit). But, unless the expenses are substantial and Samir has real prospects, it may not be worthwhile to undertake the expense and complexity of this type of arrangement.

Kaylie Handler:

This question raises potential for family law issues and, specifically, issues related to the parents’ obligation to support their child.

That aside, I wouldn’t recommend an in-trust account. Rather, the parents can just hold on to their money and pay the $11,000 annual expenses directly to the university. If the parents want to be paid back for the money given towards Samir’s education, a promissory note might make more sense, which he can only enter into once he turns 18. I would recommend Samir get independent legal advice before signing the promissory note.

Read: Parents shouldn’t shoulder university costs, say kids

What you learn

Setting up a trust account to fund an athletic child’s educational expenses is akin to gifting the money. Parents who want to be repaid should draft a promissory note. If they end up spending more than anticipated, they could pursue more aggressive routes, such as setting up a business partnership with the child.

The promissory note could provide that the loan be repayable on demand (meaning Samir doesn’t have to pay until his parents demand he pay) or be repayable on certain conditions (e.g., when he gets drafted by a major league).

Having the promissary note repayable on demand may be preferable because, under Ontario law, the limitation period for a demand obligation doesn’t begin to run until a demand is made. As such, if Samir gets a really good non-hockey job and the parents still wish to be paid back for the money spent, they can seek repayment at that time.

Read: Help clients’ kids find scholarship money

Floyd Gradley:

Having a Canadian trust with a U.S. resident as a beneficiary creates cross-border tax issues. If Peggy and Assaf set up a trust and act as trustees, the trust would be Canadian.

To avoid U.S. tax issues, they’d need a U.S. trustee. However, no trust company would want to act as a trustee for $44,000.

Normally, a trust company won’t agree to act unless it’s at least $300,000. [In contrast], the legal cost to draft a promissory note may be about $500.

by Evelyn Juan, a Toronto-based financial writer