Each year, the Federal Government of Canada collects close to $100 billion from individual tax payers; this is the government’s single biggest source of revenue.
Income splitting strategies endeavor to reduce your personal tax burden by shifting income from a higher-income spouse to a lower-income spouse, where it is taxed at a lower rate.
If your family situation is such that one spouse has a substantially higher income than the other, there are some legitimate strategies that you can adopt/employ to reduce your personal income tax burden. Consider utilizing these Canada Revenue Agency approved income-splitting techniques in order to save taxes.
For illustrative purposes, the reader is assumed to be the higher-income spouse.
1. Spousal loans
CRA allows investment loans to spouses, as long as your spouse pays interest on the loan; the minimum interest charged on such a loan is determined by CRA and is referred to as “the prescribed rate.”
The difference between the prescribed rate and the rate of return your spouse earns through investment is the value of the income split. With the prescribed rate currently set at one per cent and fixed income investments yielding over four per cent, this is a compelling strategy.
As an example, if you lend your spouse $50,000 to invest, your spouse is obliged to pay $500 in interest on the loan to you in line with the prescribed rate. As the lender you must declare this on your tax return.
Assuming that the investment earns a typical four per cent, or $2,000, your spouse would then report the balance of profit after interest $1,500 on his/her tax return.
2. Splitting your pensions
If you are retired, consider splitting 50 per cent of your pension income with your spouse. The benefits of this strategy lie primarily in reducing income taxes and may also reduce your Old Age Security clawback.
This applies to your Canada Pension Plan, private pension plan payments, and Registered Retirement Income Fund payments. Note that you have to be at least age 65 to split RRIF payments with your spouse.
CRA attribution rules require that investment income earned through gifts made to your spouse be taxed on the donor’s tax return.
However, interest on interest, or “second-generation interest” will not be taxed in your hands — rather in the hands of your spouse.
For example, if you give your spouse $50,000 to invest, and the investment earns four per cent, then $2,000 has to be reported on your tax return. The tax benefit of gifting is that your spouse can then reinvest that $2,000 of investment income, and the income earned on this amount is taxed in their hands.
4. Contributing to a spousal registered retirement savings plan
A spousal RRSP is one registered in the name of your spouse. You claim a tax deduction for making the contributions, but it is your spouse who owns the plan and will report withdrawals as taxable income as long as the money is held in the plan for three years.
5. Hiring your spouse
If you are self-employed, consider employing you spouse and paying him/her a salary. Such work might include administrative tasks such as bookkeeping or filing, or could include business development and acting as a strategist in the direction of your corporation.
Note that the salary paid has to be commensurate (consider proportionate to) with the work completed.
Examining ways to legally reduce your tax bill is a noble pursuit and can potentially lessen your tax burden. Ensure you discuss these income-splitting strategies with your tax adviser prior to execution, and keep detailed records of all transactions.
Developing strategies to mitigate your personal tax liability should be a year-round exercise — not one that is undertaken once a year when filing your annual tax return in the spring.
Alan Acton is a financial adviser in Ottawa and can be reached at firstname.lastname@example.org.The opinions expressed are those of Alan Acton and not necessarily those of Raymond James Ltd. Statistics, data, and other information are from sources believed to be reliable, but their accuracy cannot be guaranteed. This document has been prepared to assist individuals with financial concepts and is for informational purposes only.