Accountants often call the income splitting rules attribution rules. The term attribution simply means to attribute income back to the original person and effectively stop any attempt to income split.
Who Do The Income Splitting Rules Apply To?
The rules that are designed to prevent income splitting apply when you attempt to shift income to any one of the following people:
- Your spouse or common law partner,
- Any person who is under age 18 and are your children, grandchildren, nieces and nephews.
- Any person you are not dealing with at arms length, and
The rules are applied differently for each type of person listed above.
Income Splitting Between Spouses
The income splitting rules were designed to prevent you from giving your money or using a joint account to split income. If you do transfer property (for example, stocks) to your spouse directly or indirectly, the Income Tax Act says:
- The transfer is at your original cost, and
- All income and future gains will continue to be taxed your hands.
In the end, there is no tax when you transfer ownership and you continue to pay the tax just as you always had.
As luck would have it, you can still income split with your spouse if:
- Your spouse purchases the property from you with their own funds and at fair market value.
- You lend the funds to your spouse to purchase the property from you. The loan must be documented with repayment terms. Interest at the prescribed rate must be paid within 30 days of the end of the year. Of course, you include the interest as income on your tax return but your spouse can deduct the interest paid on their tax return provided the loan was used to buy income-producing investments such as stocks.
Income Splitting With Children
The income splitting rules are a little different when it comes to children under the age of 18. As mentioned above, these rules apply if you give or lend income producing property such as stocks or other investments to a minor who is your child, grandchild, niece or nephew.
When you transfer property to a minor, the Income Tax Act says:
- The transfer is deemed to be at fair market value, and
- You will continue to be taxed on income such as interest, dividends, rents and royalties, until the child is 18.
When you give or transfer property to a child, you will have a capital gain or loss and all future gains and loses are taxed to the child. However, you still have to pay tax on the investment income until the child turns 18.
You can get around the investment income attribution if the child purchases the property from you at fair market value and pays with their own funds. In this case, all of the taxes going forward are taxed in the childs’ hands.
Tax on Split Income (Kiddie Tax)
The so-called kiddie tax was introduced to reduce some of the benefits of other types of arrangements such as family trusts by applying the top marginal tax rate to all income. In addition, this income is also not eligible for deductions or tax credits (other than the dividend tax credit).
There are a number of pitfalls that can result from these types of arrangements and professional advice should be sought.
Secondary Income Can Be Split
When the income splitting rules do apply, they will only affect the first generation received from the initial transfer. Income earned from reinvestment of the first generation income is not subject to the attribution rules.
For example, if $1,000 of interest was subject to the income splitting rules and taxed in your hands, then income earned from the re-investment of the $1,000 would not.
Other Rules Affecting Income Splitting
- If a spouse or minor child has an existing commercial rate loan, a new loan or interest free loan cannot be substituted.
- The Income tax Act does not permit funds to be lent to an unrelated third party who then lends the funds to the spouse or related minor.
- A loan guarantee cannot be used to avoid the income splitting rules. A higher income spouse cannot avoid the rules by providing a loan guarantee on a low rate or interest free loan to a spouse.
- There is a variety of other rules in the Canadian Income tax act designed to prevent income splitting through a trust or corporation.
Questions About Income Splitting?
If you have a question about this article, please feel free to leave a comment in the box below. Your comments and questions are welcome and help others.
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Assume a non-resident couple where the non-working spouse takes ownership of money that is earned while non-resident. Would attribtuion rules apply on the income after becoming residents in the future. Seems most Canadians ignore it and there hasn’t been any tax court cases that I can find.
The attribution rules under the Income Tax Act, subsection 74.2(1) do not apply if the transferor was not a resident of Canada. However, at the point the where the transferor becomes a resident of Canada, the attribution rules may apply. The facts are generally outlined in a 1999 technical interpretation bulletin. If you have access to CRA technical interpretation bulletins, the document number is 1999-0013435 (E).
Hello, Tax Guy:
For the income split, I have a question about how it works: assume that my annual income of $100k, my spause stays home without income. I lend her $50k for investment. When filling tax return form, should I claim my income as $50k + the interest from my lending money to my spause, or I still have to report $100k?
Thanks for your help.
Regards,
Joe
@ Joe:
If your spouse invests the money you have lent, then the tax will be on the investment income and not the loan. In your example above, you make $100k and lend $50k to your spouse, you still pay tax on $100,000.
If you lent your spouse $50,000 and took back a promissory note with a stated interest rate at the prescribed rate, then you must declare the interest you receive from your spouse from the note (x% of $50k). Your spouse invests the $50,000 and is taxed on the investment income from that $50k and will also be able to deduct the interest paid to you.
Assuming this:
1) I lend money to my minor child.
2) The child invests the money and earns interest income.
3) The interest income is taxed in my hands.
4) The child then reinvests the income, and earnings on this portion are taxed in his hands.
I know this works if I irrevocably gift the original money to the child, but does it work if I simply lend him the money (by simply depositing it in his account) and then take it back later? (Is it unnecessary to charge the prescribed rate of interest since I am paying the tax on the first generation interest anyway?)
Thanks for your help.
Jim:
The rules apply to gifted or lent funds.
Assume a non resident has a savings account in a Canadian Bank.
His son who is a resident of Canada has access to the account, however he can only have access to the funds in the account only if he co signs with his siblings who are not residents.
Is the resident liable for any taxes even though he cannot withraw money without the signature of his siblings?
Javier:
The non-resident is the owner of the funds and and income earned in the account is subject to non-resident withholding tax. The power of attorney are not responsible for the taxes.
can i split my income with my wife if i am still working?
or does this only apply to pension incomes?
i am 65 and recieving cpp and oas, but my wife is 64
thank you
If you are receiving pension income (pension, RRIF payments, etc.) then this can be split with your spouse regardless of her age. CPP, OAS and employment income cannot be split.
I run a kennel. Can I rent my dogs to my spouse at say 20$ a month per dog declare the revenue. have her declare her expenses and the revenu she would make from selling the pups, thus shifting the income from me to her, provided we make a rental contract stating payment dates and provide reciepts?
Hello Iggy,
Unfortunately, such a plan would run afoul of the General Anti Avoidance Rules (GAAR).
would I be able to sell her the dogs for a profit and allow her to continue the breeding program? my main income is boarding and training dogs I also breed american bulldogs, I bought her the french bulldogs to breed and show but everything came in my name but she really is the one who handles all the aspects of the french bulldogs is there anyway I can transfer this income to her?
would it be simpler to pay my spouse a salary or comisson on the sale of each puppy? would a dog be considered a cca if so what class?
You can pay your spouse a salary, provided you can support that the work was done and that that amount paid was equal to what would be paid to a third party.
The dogs would be considered inventory and not a capital asset. Therefore, no CCA may be claimed. When the dog os sold, it’s cost can be deducted.
would I be able to sell her the dogs for a profit and allow her to continue the breeding program? my main income is boarding and training dogs I also breed american bulldogs, I bought her the french bulldogs to breed and show but everything came in my name but she really is the one who handles all the aspects of the french bulldogs is there anyway I can transfer this income to her?
I found this concerning attribution:
Loan or transfer made to earn business income
If a loan or transfer is made to earn business income (as opposed to income from property such as interest, dividends, rent or royalties) attribution win not apply
Iggy,
You can sell her the dogs at FMV (you’ll need proof) and she must pay for them with her own funds. Then the attribution rules will not apply. However, you must be able to fully document the source and use of funds if the CRA comes calling.
Small business owners have a high probability of being audited and I would suggest that you carefully consider all options with the help of your own accountant.
Still no answer to my question of Mar 28?
Jim,
The response is above on March 29th!
one last question, if I do put my spouse as an employee, she actually does work for me, and I keep payment records , do I have to make source deductions with every pay or do I do them all at the end of the year?
Hello Iggy:
You would treat her as an employee and remit source deductions.
Thanks tax guy. So I want to lend the money to the child to invest. How do I set this up?
1) If I contribute directly to the in-trust investment, I have technically given up the principal, as it then belongs to the child. Can I lend the money to the in-trust acct? If so, how is this documented?
2) If I lend the money directly to the child, and the child contributes to the in-trust investment, I’ve retained the right to the principal via the loan. But a child cannot legally sign a loan agreement.
So: How should the money be transferred, and how do I document it? Thanks again.
Hello Jim:
You can lend the child money provided they pay the interest on the note with their own money. You would document this with the payment terms and have both of you sign it.
In this case “in-trust” account is settled with funds provided by the child (you lent them money and they settle the account). You are only trustee because the brokerage firm cannot enforce contracts with a minor.
With respect to other funds provided or gifted, put these in a different ITF as the terms of the trust are different.
Thanks again tax guy. One last question?
1) I set up an in-trust bank account for a small child and name myself as trustee.
2) My wife lends money to the child via the trustee (me), written up as a loan to “Jim ITF Billy”. I sign the loan as trustee (because the child is too young to understand the legalities) and deposit the funds in the account.
3) I invest the funds, as trustee, on behalf of the child, in interest-bearing investments (interest, not capital gains). From the proceeds, I (as trustee) pay interest (to my wife) on the loan. The remaining income is the child’s and remains in the in-trust bank account.
Based on this scenario,
a) Did I do this right, or am I missing something?
b) Who pays the tax on the investment income? The child? Or is it attributed back to my wife?
My accountant says the CRA will attribute this back to my wife because the child is a minor and the income is interest. Many websites tell me that the child will pay the tax, though they don’t explain the details. Can you shed some light on this?
Thanks again. Sorry for the length, but good details are hard to find.
As long as the funds came from your wife’s own money (i.e. you weren’t involved other than being trustee), there would be no attribution as the scenario is an arms length transaction.
Out of curiosity, what exactly are your trying to achieve and why?
You said that “there would be attribution” — did you mean to say that there would be “no attribution” (i.e. that the income would be taxed in the child’s hands)?
What am I trying to achieve? Income splitting. I’m wish to invest my wife’s money to earn interest that will be taxed in my kids’ hands, making use of their basic exemptions.
Hello Jim,
I did mean “no attribution” (I’ve edited my previous comment).
OK, so to split income with the kids, you or your wife can lend them the funds to invest. As long as the children pay you interest at the prescribed rate and from their own funds – on-time(which you declare as income and they deduct from income), the the transactions are fine.
The account you invest with their loan proceeds should be kept separate from any other types of funds. For example, if you or your wife, your parents, or your brothers or sisters decide to gift money to your kids, then these funds should be kept in a different ITF account since attribution would apply and keeping track of who gifted what funds. Also, if your kids have an account that is used to invest funds from the CTB or their own job, this should be kept separate from funds subject to attribution. This keeps it ll clean.
One final note about attribution and income splitting. The benefits of income splitting can be substantial when we consider large amounts of income. However, small amounts prove negligible. As an example, assume you already make more than $126,000 and have a marginal tax rate of 45%. If you lend $10,000 to the kids at 1% and they have not other income, the annual tax benefit from the arrangement at a 6% return (straight income) is only $225.
Keep in mind that, if you invest in stocks only using a buy and hold and the yield is 2%, then the kids still pay zero tax and pay $45 on the interest income. If the dividend had been taxed to you and there was no loan, you would have only paid about 25% on the dividend or $50. So all the work of lending money to the kids results in you saving $5!
If you just give the kids cash and have them invest in non-dividend paying stocks, everything is taxed to them anyway. You need to be aware of the implication of marginal tax rates as well.
I am trying to veryify the prescribed interest rate currently charges on non-arm’s length loans through the CRA website – and I can’t find it! Is it still 1%. How do you look it up?
Another Jim
JimK:
The rate is stated by the CRA. Look at the most recent release http://www.cra-arc.gc.ca/tx/fq/ntrst_rts/menu-eng.html
I have a friend who has an ITF for her 17 year old son.
The ITF is under her Social Insurance Number.
Understand she declares the interest and dividends,
but can the son take the capital loss/gains?
thank you!
Hi Jim
I have a friend who has an ITF for her 17 year old son.
The ITF is under her Social Insurance Number.
Understand she declares the interest and dividends,
but can the son take the capital loss/gains?
thank you!
Hello Jan:
The child must take the capital gains.
Taxman said: “You need to be aware of the implication of marginal tax rates as well.”
Can you explain this? thanks.
Hello,
If someone receives a severance/retiring allowance after being terminated from an employment, can they split this retiring allowance with their spouse even if they are no way near retirement age? I’ve heard that the CRA is simplifying the T-slips so that retiring allowances will need to be reported on the new T4 in new boxes 66 and 67. Will this affect taxpayers’ ability to split this income? Thank you.
Hello Lynn,
Retiring allowances cannot under any circumstances be split with a spouse. Only income eligible for the pension income tax credit can be split (the retiring allowance does not come within this definition).
Hi Tax Guy,
I’m interested to know if its possible to transfer income from my common law spouse so that he pays less tax. Say he makes 190K and I make 28K. How would we do that?
Here are some common ways to do this:
1. Use a spousal RRSP to affect equal retirement income,
2. If you are self-employed, hire your spouse to work in your business,
3. The higher income spouse pays all family expenses, including the taxes of the lower income spouse. The lower income spouse then invests their earnings, or
4. Loan your spouse money with a loan at the prescribed rate and have your spouse invest the loan proceeds. Ensure you know all of the rules to avoid the transaction crashing.
Hi Tax Guy,
First and foremost – many thanks for your kind help. I highly appreciate it.
I am a salaried professional, and my wife is non-working (has been non-working since we moved to Canada in 2007) and stays at home all the time with our less-than-a-month old kid. As it is obvious, I earn and I spend on all the expenses related to the three of us, including mortgage payments.
1. CRA asked my wife, instead of me, to apply for the CCTB (incl. UCCB) – Ques: Should it matter to me or her tax-wise?
2. Since my wife isn’t working, I consider the three of us having equal rights on my income – Ques: Is it acceptable by the CRA?
3. My wife opened a TFSA stock trading account in 2010, investing $5,000, and will most likely have net capital gains and dividend income at the end of 2010 – Ques: I don’t want to treat it as a loan to her, so is it acceptable by the CRA that she is investing money despite no income?
4. The online discount brokerage told her that all her capital gains/losses and dividend income are tax-free, given she has a TFSA trading account – Ques: Does she need to file a tax return and if so, does she need to report those capital gains/losses and dividend income, although they are from TFSA?
Thanks again for all your help.
Hello Konrak,
If your wife does not work, it is probably better for her to claim the CCTB and UCCB. The UCCB is a taxable receipt and if her income is under $10,300 then it will be tax free.
In terms of income, it is taxable in the hands of the person who earned it. So your employment income is only taxable in your hands. If you use your employment income to invest, then the investment income is taxable in your hands. You cannot transfer property to your children or spouse directly to have income taxed in their hands.
There is no tax attribution or tax on funds inside the TFSA. If you give funds to your wife and she laces it in her TFSA, the investment income and gains are not taxable at all and there is no issues withdrawing the funds.
The TFSA does not require a tax return.
I would strongly urge you to use the services of an accountant
My ex-husband had me sign an agreement with a clause in it that would allow him to declare $6000.00 for the year 2009 which I did not receive from him. My lawyer urged me to accept this agreement but now I will have to declare $6000.00 on my taxes, which have already been filed and pay tax on that money. Is this legal? It doesn’t seem fair to me that spousal support depend on a clause like this and I don’t understand why my lawyer would agree to it when he is the one I am counting on to act in my best interest.
I work for my husband and we income split. Is it necessary for him to actually write me a paycheque on a regular basis?
Hi Brenda,
A trail is always better than cash. Cheques provide a good audit trail although not required.
Similar to Brenda’s question. I am a self employed Realtor and I pay my wife. Do I need to provide a T4? Can she claim what I pay her as occasional earnings?
Hello Kurt,
If you pay her more than $500 you must issue a T4: http://www.cra-arc.gc.ca/tx/bsnss/tpcs/pyrll/rtrns/t4/slps/whn-eng.html