Categories: Personal Income Tax
Tags: Income Splitting, Loans To Spouse, RRSP, spousal rrsp, TFSA
The Right and Wrong Way To Split Income
Published on July 27th, 2009
Written by: Tax Guy
As an individuals income increases so does the rate of income tax charged. At the federal level, you will pay 15% on the first $40,726 of income, 22% on the next $40,726, 26% on the next $44,812 and 29% on any income over $126,264. Each province has similar graduated tax rates (except Alberta, which charges a flat 10% on all income).
What Does This Mean?
An individual taxpayer earning $80,000 per year will pay around $20,000 of combined federal and provincial taxes. If this individual could allocate $40,000 to his or her spouse, they would each pay around $7,000 each of tax. Splitting income would save this couple $6,000 a year and reduce their taxes by 30%!
The Wrong Way To Split Income
The Canadian Income Tax Act contains a set of rules that are specifically designed to prevent individuals from shifting income between family member. Some common misconceptions surrounding income splitting include:
- Joint Accounts. Married couples often assume they can split their investment income in a joint account. In fact, the allocation of income between the joint owners is based on their proportional contributions to the account.
- Gifting To A Spouse. If you gift assets (or cash) to your spouse, any investment income and capital gains will continue to be taxed in your hands unless your spouse pays for the assets with their own money.
- Gifts To Minor Children. Setting up a trust, informal trust and investing for a child, grandchild, niece or nephew will not completely avoid income being taxed in your hands. You will be responsible for the tax on dividends and interest until the child turns 18 but the child will be taxed on capital gains.
While the Income Tax Act limits our ability to split income, there are perfectly legitimate ways for family members to split income.
Top 6 Ways To Split Income
- Lend Your Spouse Money – The higher income spouse lends the lower income spouse funds and takes back a note with an interest rate at the CRA’s prescribed rate. The lower income spouse invests the funds and will pay tax on the investment income as long as he or she actually pays the other spouse the interest within 30 days of the end of the tax year.
- Tax Free Savings Accounts (TFSA) – The TFSA has a specifically allows the account to be used for income splitting. The higher income spouse can gift funds to contribute to the lower income spouse’s TFSA. The income earned in the TFSA is tax-free and not subject to attribution. In addition, if withdrawn by the lower income spouse is not subject to attribution.
- Spousal RRSPs – The higher income spouse can contribute to the lower income spouse’s RRSP. The goal is to ensure both RRSPs are equal value and at retirement, the income streams will be the same.
Be aware that if the lower income spouse withdraws from the spousal RRSP contributions made by the other spouse will be taxed in the other spouses’ hands if made within the two prior years.
- Asset Shifting - This technique is simply swapping assets between spouses. If one spouse owns an asset that does not generate income (such as a cottage), that asset may be swapped for an income producing asset of equal value owned by the other spouse.
- Pay Household Expenses – In this scenario, the higher income spouse pays all of the household expenses, including the taxes of the lower income spouse. This technique frees up the lower income spouse’s income available for investmenting
- Gifting – As mentioned above, a gift to a spouse will mean that income will be taxed attributed back to the gifting spouse. However, when the initial income received is subsequently invested, there is no attribution on this secondary income.
Other income splitting strategies that utilize testamentary trusts or businesses may be also used. And if you are interested in these other methods, you should seek professional advice.
Your Thoughts Or Questions?
If you have something to contribute or have a comment on this article, please feel free to leave a comment below.
Can I gift money to my spouse to pay back student/consumer loans, so she can invest instead of focusing on paying back her debt?
What about investment loans? (I assume this would be too easy)
@ Ryan:
If your spouse used the gift to pay off her own debt and then used the funds previously used to service debt for investment, then the investment income would be taxed in her hands.
You cannot guarantee investment loans for your wife and avoid attribution. You can lend funds to her at the CRA’s prescribed rate. As long as she actually pays you the interest by January 30th from her own funds, then the investment income is taxed in her hands…The interest she pays you is a deduction for her and you must include it in your income.
Hi, my father has declared money under my name for which I have received a t4a from his company. I have never actually had any money deposited into my accounts however. Does this type of action fall under income splitting, or is this simply hiding money from the governmet? Please let me know
@Cory – A business may employ family members as long as they actually do the work and are paid the market rate for the work. It may be possible that the funds are being diverted to a trust in which you are the beneficiary. If so, then this would be a reasonable set up.
hi, can we split the income between spouses and lower the taxes. If the anuual income of one is $80,000 and the other is zero, can we split 40k each so that we pay lower taxes..
Or please suggest other options.
Much appreciated. Thanks
@Miller: The article mentions some of the ways income can be split but unless you receive pension income eligible for the pension income tax credit, you can’t just allocate your income to your spouse.
Take a loot at http://blog.taxresource.ca/what-are-the-canadian-income-splitting-rules/
http://blog.taxresource.ca/tax-planning-and-income-splitting-opportunities-in-canada/
http://blog.taxresource.ca/what-are-the-canadian-income-splitting-rules/
Hi,
I have a question about investment income. In my family I have two adult daughters all living under the same roof, where one is the lowest income earner in the family. Could I, my husband, and my other daughter who earns a higher salary, lend money to the lower income daughter for investment? Who would be taxed for the income earned from this investment (of course assuming all our other incomes have been subjected to normal income tax rates)? Would it be different if the money was gifted? If you could direct me to any resources with respect to this, I would greatly appreciate it! Thanks!
Hi Melissa,
A person can loan funds to anyone and to ensure there is an enforceable contract, there should be interest. The lender reports the interest as income while the borrower reports the income earned on the investment as income. The loans should have at least the prescribed rate or a commercial rate of interest.
I will note that you should run the numbers. Typically, small amounts have little if any benefit. To be beneficial the loans must be long-term and the amounts substantial (several hundereds of thousands) to be worth the effort.
Hi,
My spouse and I invested together into some stocks in 2009, but the way we did this may not have been the smartest. The trading account is in my name and my spouse essentially gave me 50% of the purchase price of the shares. I used that money and 50% of my own money to purchase certain stocks which did very well for us. I sold the shares in 2010.
I can on the tax forms set out that each of us bought 50% of the shares (essentially by splitting the total number of shares among the two of us), but there is no formal agreement outside of an oral agreement to jointly contribute the money into the stocks and to split the profits, if any. It would be much better for us if she could show the profit as hers on 50% of the shares as the capital gains push me into the next tax bracket if fully attributed to me.
If we proceed on that basis will the CRA have a problem with this? It would be hard to prove in an audit except for showing bank transfers.
Thanks.
The CRA would consider the facts and look at where the sources of the funds came from. They can trace the actual proportion, although only in an audit.
I would normally suggest using two separate accounts just to make things clean and you can just move her share to her account and yours to your account.
Beyond that I would just ensure you properly report the income on your tax returns.
My normal income is around 50000 I received a starting bonus of 17000 I paid 13000 in income tax If I don’t add the bonus I can get close to 9000 back in taxes after all is figured out. If I add the bonus it basicly takes 7500 out of my refund away I am trying to figure out what to do. Any ideas on what to do.I cannot split income with my wife just have a regular T4
There is little you can do about the bonus other than contribute it to an RRSP or spousal RRSP and deduct the bonus. Of course you should have contribution room available.