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 In addition, if withdrawn by the lower income spouse is not subject to attribution.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?
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Thanks very much for this post and for your website, which I will make a note of in my booksmarks.
Despite the recession, I’ve done very well in my direct trading account. In the last couple of years, I’ve been keeping more or less strict paper trails to show that my income is what I am investing in my investment account. But if we are audited (and my spouse makes much more than I do), I wonder if it would suffice to argue the following: (1) My accrued net income over the last ten years exceeds the current book value of my investment portfolio (if you count also some regular gifts at Xmas and b-day from my US based dad, ca. $4000 per year); (2) my wife’s salary pays all expenses. Will CRA expect that these strict paper trails prove that I invested only my own income? The fact is that we have a joint accounts into which both our pay cheques and savings go and the things get fairly tangled up in the process.
When does the CRA start to care about attribution? Are they going to attack a couple if the principle invested is, let’s say, under $100,000? I wasn’t worried until this year when my portfolio is doing better and I am worried that it may attract attention. I worry that CRA may come ringing at our door saying, how is it that you have a net investments so high, when your earned income is only around 21K? And then I will have to prove that every penny of the principle came out of my pocket.
For me the issues is also related to cash flow. For the first few years of the last decade, we devoted all our resources towards our mortgage until it was completely paid off. I’ve talked to an accountant who says I have nothing to worry about, but then he tends to more much more relaxed than my wife’s accountant. I read widely in investing and often come across warnings about attribution, and I start going nuts again.
Finally, is it really the case that my wife can pay my income taxes? If so, then that gives a fair bit of breathing room. If that’s the case, then I should be investing my gross income and not my net (I have been trying to stick with the net thus far).
@ Petros:
A couple of thoughts:
First, the CRA looks at auditing from a risk approach. The higher the probability of a taxpayer taking advantage, the higher the probability the taxpayer will be audited. This means that the self-employed and those with employment expenses are more likely to be audited than someone getting only T4 income.
Second, the Income Tax Act requires that every taxpayer account for every dollar earned and the investment income thereof! This means that everyone is required to account for each dollar brought to the marriage and earned in the marriage.
From a tactical point of view, brokerage accounts should be held joint only for estate planning purposes and no other reason. Thus, I always suggest that the husband maintain his own brokerage account and make his wife joint owner and vice-versa. Funds from each spouse should not be co-mingled.
Some Thoughts On Record keeping And Strategy
1. From a record keeping point of view and a tax audit trail, it would be cleaner if each of you received paycheques into individual bank accounts and then funded your joint bank account and brokerage accounts from the individual accounts. However, the reality is that few people do this.
2. The higher income spouse should pay all of the family expenses including the income tax bill of the lower income spouse. The lower income spouse then invests the bulk of their funds and the higher income spouse invests less. The goal here is to attempt to ensure the taxable incomes of both spouses are equal.
Thanks for the advice. We don’t have separate chequing accounts and I think that is a good a suggestion moving forward. We do keep our brokerage accounts completely separate.
My accountant says his brother works for CRA and they only go after the big fish. I wonder, because my total income, including investments is still small (under 40K), whether CRA would even be interested in auditing my investment income and paper trails. They might find a few discrepancies but it wouldn’t net them very much in the end. But since I’m hoping to earn more through investing in the future, I will probably take your advice about keeping separate bank accounts for our pay cheques.
@ Petros:
I agree the CRA goes after big fish but I always feel its best to be safe than sorry.
Thanks again: did you see this article at cbc.ca: In my view it makes a farce of the attribution law; if you can gift money and assets to a stranger, than I should divorce my wife and renounce my children so that they are at arms length.
http://www.cbc.ca/canada/montreal/story/2009/08/20/montreal-stripper-canada-revenue-agency-gift-tax-court-decision.html
I think divorce and renouncing children would be a drastic step and the associate legal costs and family disruption would make that strategy cost prohibitive. Especially since the divorce would need to be real and permanent (If you move in together and have children, you are considered common law spouses and attribution applies!).
As for the case, I’m not familiar with it but it appears the CRA was arguing that she was really a prostitute, who would be self-employed and therefore earning taxable income.
From your opening suggestions for income splitting you indicate that the higher income spouse can gift funds for the lower income spouse to contribute to their own TFSA. And that on withdrawal these funds and any growth belong to the lower income spouse with no attribution.
Can the lower income spouse then take these funds and invest them with no worries about attribution? It sounds like I could give my wife $5000 today to put in her TFSA and she could withdraw it before year end and put that money into her own non-registered investment account. When January rolls around I can fund the replacement of the $5000 plus another $5000, which she could then repeat the process. In a matter of a couple short months my wife now has about $15,000 in her investment account with no attribution.
Are there rules that disallow this? Thanks.
@ Barney,
The wording in the literature speaks to attribution not applying as long as it is in the TFSA. It would appear that the Act allows the income to grow tax-free but once it is withdrawn it may be subject to attribution again.
The problem is that the legislation is so new and there are very few interpretation letters available from the CRA on the account. None ask this question.
I spoke with my lawyer last night and he affirmed your advice to set up a new account which I did today. Since I’m really just starting out right now and I’m not paying very much tax, if I get things going the right now, I can avoid problems in the future. He said it is very problematic because of LILO (last in last out) or FIFO (first in first out) to have our pay cheques going into the same account. These are cash flow issues; and apparently CRA can be quite the sticklers when it comes to this. But then the question comes to mind: if the one spouse can pay all household expenses including the tax, how is this supposed to be done when the tax is withheld and I never see it in the first place. Can my spouse then pay me back for the tax I paid in withholdings? My lawyer gave me the impression that that CRA wouldn’t like that. Thanks again for your website.
@ Petros:
Why not use 2 joint chequing accounts? My wife and I do. My pay goes into one hers goes to the other: We both have access to the accounts. There is no question whose money is in what account – If you use PC Financial there are no fees.
Thanks for the tip; I’ve solved the problem by opening a new account. My question, however, regarded the information that you provide in your post about the higher earning spouse paying the taxes of the lower earning spouse. But if the tax is withheld, then there is no cash flow to prove that its the lower earning spouse’s money. I was asking if you know whether the higher earner can “pay back” the lower earner.
@ Petros:
It sounds like you are over thinking this stuff. Realistically, if you both make less than $41,000 a year then this stuff makes little of any difference and the amount of effort versus the reward is negligible – At the very high end of the range, you might be able to save a couple of hundred dollars a year.
Where one makes substantially more than the other (i.e. one spouse makes $30,000 [pays 21% tax] and the other makes $150,000 [pays 45% tax]) then income splitting becomes attractive.
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.