Income splitting is a tax-planning technique designed to shift income from a taxpayer paying a high rate of tax to another taxpayer within the family unit paying tax at a lower rate. Unfortunately, there are a number of legislative provisions—“attribution rules” and other anti-avoidance measures—designed to prevent saving taxes by shifting income between taxpayers.
There are still a number of legitimate tax-planning arrangements that can be used to effectively redistribute income in a family unit:
- Make contributions to a spousal RRSP. Setting up a spousal RRSP is a good idea if you expect your spouse or common-law partner to be in a lower tax bracket than you on retirement. When funds are withdrawn from the spousal RRSP, they are taxed in your spouse’s or common-law partner’s hands at his or her lower tax rate (this arrangement is subject to special rules to prevent abuse). This reduces your family’s total tax bill. This strategy also means that benefits such as the pension credit can be made available to both of you, and you may reduce your exposure to the Old Age Security (OAS) clawback
- Share CPP payments – The Canada Pension Plan Act permits you to assign a portion of your retirement pension to your spouse or common-law partner. If your spouse or common-law partner is in a lower tax bracket than you, shifting this income to his or her hands helps lower the total family tax bill. The number of months you have lived together is a factor in determining how the benefits are split.
- Pension income splitting. If both spouses are in the same tax bracket, income splitting will not provide the benefit of a reduction in the marginal tax rate. However, pension splitting may still be useful if it creates or increases a pension tax credit for the spouse.
- Loan to spouse or partner at prescribed rate 1% to invest. The net tax savings to the couple would be having the dividends taxed in spouse or partner’s hands at the lowest rate.
- Transfer or sell assets to family members for FMV consideration, any subsequent capital gain or loss realized on a sale to a third party can be taxed in your spouse or common-law partner’s hands (rather than in your hands).
- Gift to minor children capital assets that are appreciating in value so they can earn capital gains not subject to attribution.
- Give cash or other assets to your adult children. Gifts of cash could enable them to maximize their deductible RRSP contributions.
- Take advantage of the fact that income earned on income is not subject to the attribution rules. Although the initial income earned on property loaned to a non-arm’s-length person may be attributed back to the person making the transfer, income earned on that income will not be attributed.
- Invest child tax benefit payments in your child’s name.
- Contribute to an RESP.
If you are small business owners, the ability to sprinkle income among family members was greatly curtailed. However, there still are some limited exceptions to the new rule that will be discussed in our next newsletter.
It’s crucial that you confer with your tax adviser, who can review your personal situation and give you advice about which income-splitting strategies best fit your circumstances.