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The Right and Wrong Way To Split Income

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:

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

  1. 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.
  2. 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.

  1. 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.
  2. 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
  3. 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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