Income Splitting 101: Tips On Keeping It In The Family

South of the border, the heads of U.S. households can elect to file joint income tax returns, pooling their income and deductions.  This option brings considerable tax savings to families in which one spouse has a significantly higher income than the other; their joint tax bracket will likely be lower than it would be otherwise.

Related: Tax Considerations For Single-Income Households

In Canada, we’ve no such option.  Most spouses pool their resources to pay the bills, buy groceries and handle household expenses, but Canada treats couples like roommates living in the same house.  That was how Prime Minister Stephen Harper described the tax laws at a press conference in March 2011.  He said the situation was neither realistic nor fair.

Federal Promises:

Harper’s federal government announced a measure he said would provide significant tax relief to families with children younger than 18.  The government’s plan to allow wage-earners to split up to $50,000 of household income would save eligible families an average of $1,300 in federal taxes a year, Harper said.

That’s a significant impact, and one that will be welcomed by families with one person earning considerably more income than the other.  And the effect on single-income families will be even more pronounced.

The catch?  The measure won’t take effect until the federal budget is balanced.  That’s a moving target, but at the moment it looks like that will happen in 2015-2016.

In the meantime, there are some legitimate options for Canadian families looking to ease the tax burden of the biggest earner in the household, although the Canada Revenue Agency (CRA) is vigilant about making sure every rule is followed.

Income Splitting Tips:

Contributing to registered savings plans for other household members is a popular option for sharing income.  For example, contributing to a spouse’s RRSP provides immediate tax relief, along with splitting the tax burden down the line when you begin to withdraw from it.  However, your RRSP contribution limit applies to both plans; if your limit is $10,000, you’d have to split that amount between your plan and your spouse’s.

Registered Education Savings Plans (RESPs) are also an effective income splitting strategy.  Your investment can grow tax-free and your children claim the income at a time when they have little or no money coming in.  Meanwhile, the income you receive through the Child Tax Benefit and Universal Child Care Benefit can be funnelled into an account in your child’s name, and it will be treated as his or her income.

You can also contribute to a family member’s tax-free savings accounts (TFSA), up to that person’s contribution limit.  There’s no immediate tax relief from the contributions, but the deposits grow tax-free in each account.

If you have your own business, you can hire your spouse or child.  However, the wages are only deductible if they are “reasonable” and “documented.”  All the normal paperwork and deductions for bringing on a new hire apply, you have to issue T4s, and the work actually has to be done.

Spousal loans are an increasingly popular income splitting strategy, with a low interest rate prescribed by the CRA.  It’s back to the historically low 1% after a bump to 2% in the last quarter of 2013.

Related: Is Your Investment Loan Tax Deductible?

Spousal loans must be officially documented like any other loan, and the interest has to be paid annually before January 30.  But the interest rate is locked in for the life of the loan, so the lower-income-earning spouse only has to make a 1% return on investment to pay the interest.

Interest charged is taxable for the lender, but interest paid is deductible for the person receiving the loan.  Don’t miss the payment deadline, though, or future income from the investment will be charged as income for the lending spouse.

Pensioners have a number of income splitting options.  If both partners are 60 or older, their Canada Pension Plan (CPP) income can be split depending on how long they have lived together and when they were contributing to the plan, which is helpful for reducing the income of the partner with the highest CPP entitlement.

Another advantage is that couples only need to apply for this once, whereas they must apply every year to split Registered Retirement Investment Fund (RRIF) and RRSP annuity income.

Since 2006, couples have been able to split income from company pension plans.  Unlike RRIF and RRSP splitting, which can only begin at age 65, couples can start splitting company pension income at any time.

With the ability to split pension income, you may be wondering if a spousal RRSP is really necessary.  Most tax professionals would suggest continuing with the spousal RRSP, particularly for those looking to retire before 65.

If a spousal plan is in place and a couple wants to convert it into a RRIF, the income from it will be included on the spouse’s return.  If only one partner has a plan, the income cannot be split under the pension-income splitting provisions until he or she turns 65.

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In addition, spouses may also feel more secure with their own RRSP.  It is their money.  With the pension income splitting provisions, all that is happening is that the higher-income spouse is unloading income on their return.

So, if you and your significant other want to split the tax bill before the feds officially enact income sharing, you may want to talk to your local tax professional to choose the strategies that work for you and do not attract attention from the CRA.

This information was provided by H&R Block.

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  1. Dan @ Our Big Fat Wallet on March 13, 2014 at 9:34 pm

    Good information, I should mention that income paid to family members seems to be on CRA’s radar at times. I’ve seen a few cases where the business owner had to justify the salaries paid to their family as they could be deemed excessive in some cases. It needs to be reasonable and comparable to the current local market rates for a similar role (ie no $150k salaries for family that does light admin work)

    • Money Saving on March 14, 2014 at 11:23 am

      Exactly – it’s all about keeping it reasonable looking! Anything that stands out will be tracked down if you go overboard.

  2. Brian So on March 14, 2014 at 12:36 am

    Wow, you’ve covered pretty much every income splitting opportunities there are. Nice job!

    With regards to lending to a spouse, is it worth it? The benefit is that the higher income spouse can deduct interest, but wouldn’t tax on the investment returns paid by the higher income spouse not make this strategy worthwhile? I haven’t done the math but this always pops up in my head when I hear about this strategy.

    • aB on March 14, 2014 at 8:21 am

      My understanding is as follows:
      Lending to a spouse is so the lower tax rate spouse pays the tax on the investment returns. Lower tax rate spouse can deduct the interest paid to the higher tax rate spouse, but the higher tax rate spouse has to pay tax on the interest received.

      What I am curious about is if you can use lower tax rate spouse’s TFSA as a way to get around the attribution rules.
      example/ Higher tax rate spouse puts $30k into lower tax rate spouse’s TFSA in Jan. In Dec, lower tax rate spouse takes it all out, to invest in non-reg. Repeat..?

      • Brian So on March 14, 2014 at 9:27 pm

        I thought the idea behind it was the reverse: lower income spouse lending to higher income spouse. Although your way makes sense also.

        I think your example would be ok. The higher income spouse is putting in after-tax dollars into his spouse’s TFSA, so the government already took a cut.

        Attribution rules are for current investments that the higher income spouse holds. Any gift/transfer to the lower income spouse will result in interest/capital gains/dividends being attributed back to the higher income spouse. In order to avoid attribution, you either sell it to your spouse for FMV or have the spouse pay interest for lending the investments.

  3. Blake Schmidt on March 14, 2014 at 5:30 am

    I have heard that the PC’s are going to use income splitting as a election goodie . That would be great.

    • Chris Pepper on March 14, 2014 at 5:53 am

      If income splitting up to %50,000 was in effect, my family would have saved $5000 in taxes. That’s $5000 we could use for RRSPs, RESPs, TFSAs, or to pay down debt. Why would people that could both have pension plans and benefits from work be taxed more favorably than a single income earner?
      I’ve also read that this would help just the very wealthy, but here is a real example of a middle income family benefiting from a tax savings plan that will hopefully be implemented by government.
      I’m not a huge corporation trying to avoid taxes altogether, I just want to pay the same as others who make as much as we do.

  4. Robert on March 14, 2014 at 6:31 am

    Good article on the current state. I certainly hope the government does not proceed with making us single parents less equal in taxation!

  5. Ant on March 14, 2014 at 7:30 am

    Just to double check- if the two people make the same income, there’s no advantage in doing this correct? Would there be decision points where you split and don’t?

    • Cleo Hamel on March 17, 2014 at 2:10 pm

      Generally yes, but not necessarily. It depends on what type of income they have. For example, if only one spouse was receiving OAS benefits and both were in the threshold zone for the clawback, it would be beneficial to transfer income to the other spouse.

  6. Marie Zalbe on March 15, 2014 at 4:55 am

    Pretty good! You’ve covered every income splitting opportunities there are. Keep up the good work!

  7. Kurt Pearson on March 15, 2014 at 5:42 pm

    So, based on that can I hire my stay-at-home wife as a house keeper/nanny? Hmm… This income splitting thing would be huge for me!

  8. Rosemary Wells on March 16, 2014 at 7:13 am

    Are you sure about the CPP being eligible for splitting. I thought it was only private pensions.

    • Cleo Hamel on March 17, 2014 at 2:11 pm

      CPP benefits are not eligible for pension splitting on the tax return. However, it may be possible to arrange with Service Canada to at least partially split the benefits depending on how long you lived together while you were contributing to the plan.

    • john on April 23, 2014 at 7:16 am

      Service Canada will arrange to partially split the benefits depending on how long you lived together while you were contributing to the plan. Both will receive a CPP cheque every month. It works well and saves a lot in taxes.

  9. JimP on April 19, 2014 at 5:06 pm


    Very good post. If I could suggest an improvement, I am always a big fan of keeping it simple for people, because sometimes they mistakenly look at the most complicated options first. I give advice to friends and family, but I tell people not to go on to the next ‘step’ if they haven’t completed the previous step. I realize it’s not always a one size fits all approach, but it applies to most people.

    1. Maximize spousal RRSP contributions for high income earner. RRSPs provide maximum tax savings that are hard to match. If the high income spouse isn’t maximizing their RRSP, don’t go any further. Don’t bother having the lower income spouse max their RRSP contributions at this step. I do like the suggestion of balancing the portfolio between spouses, or even stacking it slightly towards the spouse that is likely to draw on RRSPs first. I do this by switching from spousal to contributor every other year.

    2. Maximize RESPs up to the CESG limit ($2500 per child). You can’t beat the instant 20% return on your investment. Remember if you missed a year you can contribute a max of two years contributions each year to catch up. Don’t go past this step if you haven’t maximized your RESP up to the lifetime contribution limit for all children.

    3. If the lower income spouse is paying any income tax, it is now time to look at investing in their RRSP if they have room. Go past this step if the lower income spouse has no RRSP room OR there is little tax advantage for further contributions. For now, save the contribution room for a spouse that will go back to work or make more money later in their career.

    4. Maximize TFSA contributions for the lower income spouse. This is a great one, because if you ever need the money, you can extract it at the lower income spouse’s tax rate. You can do this for RRSPs but there are more rules to prevent this, especially if you are doing spousal RRSP contributions. If your spouse has any TFSA room, don’t go any further until you have maxed this out.

    5. Maximize your own TFSA contributions. I believe this is simpler for tax free income growth than anything else that follows. This doesn’t split income, but I think this is better for you than step 6.

    6. If you made it to this step, you are now in great financial shape, and you are looking for more clever ways to get tax free or lower tax income investments. Now you can start thinking of the ‘spousal loan’ approach. Remember, what you are doing here is trying to avoid paying tax on investment income on the high income spousal return, and transferring all the investment income to the lower spouse’s return to pay less taxes overall. But you are still paying taxes on the investment growth, whereas all the previous steps are focused on ensuring you pay no taxes on investment growth.

    Comments welcome, this is the strategy I used when my wife was not working, and I am still using this now that she has gone back to work part time.


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