Our Canadian tax system has graduated tax brackets that result in people with earnings in higher tax brackets paying a greater amount of tax.
Income splitting is a tax planning technique designed to shift income from a high-income earning taxpayer to a family member at a lower tax rate.
The Income Tax Act has clear rules about income splitting. Here are some strategies that may reduce your overall family tax bill.
7 Income Splitting Strategies For Families
1) Lend money to your spouse
Adam lends his wife Amy $200,000 at the prescribed government rate of 1% secured by a written promissory note. Amy invests the money in dividend paying stocks with a current yield of 4%.
Before January 30th each year she pays Adam the interest amount of $2000. The $8000 investment return is taxed at Amy’s lower rate and Adam includes the interest on his tax return.
2) Gift money to your spouse
Barney doesn’t want to set up a loan to his wife, Betty so he gives her $200,000 to invest. The annual rate of return is 4%.
In this case, Barney must declare the investment income as it is attributable to him. However, the second-generation income (income on income) is claimed by Betty. To simplify their bookkeeping, Betty moves this earned income into a separate account.
3) Pay all the household expenses
Carter pays all the family expenses with his higher earnings. His spouse, Cindy, earns a much lower income because she works only part-time.
She invests her income and the returns on these investments are taxed at her lower rate.
4) Spousal RRSP
He contributes to a Spousal RRSP to receive the tax deduction now, and when his wife Doreen ultimately withdraws the funds (keeping in mind the 3-year attribution period), the money will be taxed in her hands.
5) Invest in a minor child’s name
Edward and Ellen have opened “in trust” accounts for each of their grandchildren – Emma, Elijah and Eloise.
They have chosen investments with good growth potential as capital gains will be taxed in the children’s hands, but interest and dividends will be attributable to the grandparents. The children’s parents, Ernest and Emily, are also investing the child tax benefit in their children’s names. There are no attribution rules with these funds.
6) Splitting CPP benefits
You must submit an application to share your CPP pension. Both spouses must be age 60 or older.
Gordon receives $13,000 in CPP benefits annually. His wife Geraldine has never paid into the plan. Gordon applies to split his payments with his wife and they each receive $7,500.
Harvey is entitled to $10,000 in annual CPP benefits and his spouse Henrietta receives $4,000. They apply to split the benefits and each receives $7,000.
The split is determined by CPP, not the applicant. In most cases, but not always, it is a 50/50 split. The portion shared is based on the number of months lived together.
7) Pension income splitting
Ingrid receives retirement benefits from her company’s registered pension plan. When she completes her income tax return she can allocate up to half the amount to her spouse Ian who has no pension plan.
If you are 65 or older, RRSP and RRIF withdrawals can also be split up to 50%.
It doesn’t have to be the same amount each year or the same percentage. The extent to which pension income splitting will be beneficial will depend on the marginal tax bracket of each spouse, as well as the amount of qualifying income that can be split. You can choose the best solution for your own situation.
Both spouses will be able to claim the pension income credit.