Tax Tip Thursday

Four Ways to Split Income with Your Partner

Today we are going to talk about ways to legitimately split your income.

Canadians file individual tax returns and pay tax at progressively higher rates as income increases. Canada’s laws on income splitting are not as generous as other countries, but there are a few strategies that taxpayers here who are single, married or have children can pursue to split income and lower their tax bills.

Self Employed Strategies

Being Self Employed offers unique opportunities that are not available to employees.

  1. You can employ family members and pay them a tax-deductible salary. This can be advantageous when they have family members whose incomes and tax rates are lower. The salaries are tax deductible to the business. The salary should be reported on a T4 slip just as you would for another employee. There are 3 conditions:
    • the salary is actually paid to them.
    • The work they do must also be necessary for earning the business income.
    • it must be reasonable given their age, and in line with what you might pay someone else.
  2. Business owners can split income with a corporation by incorporating their business. Without going into a lot of detail, if you make more money that you spend on an annual basis and you are incorporated, you have the opportunity to defer up to 40% tax on that excess income! When a corporation earns income, you only pay personal tax on the income that is paid out personally as either a salary (as an employee) or as a dividend (as a shareholder). Business income that is left in a corporation and not withdrawn from personal use is only subject to corporate tax. Corporate tax rates for small business (under $500k in net income) are 12.2% in Ontario. By comparison, the top personal tax rate in Canada is as high as 54.3 per cent. This means when you split income with a corporation, you can defer up to about 40 per cent tax on that income. This higher after-tax income can be used to reinvest in the business or to invest in stocks, bonds, mutual funds, exchange traded funds, real estate, or other investments in a corporate investment account. There are also opportunities to split your income with your spouse or children through the corporation, but there are some very specific rules which need to be adhered too. Until 2018, it was possible for business owners to split income with adult family members by paying them dividends on shares they owned of a corporation. Beginning that year, tax on split income (TOSI) rules came into effect and made it more difficult to pay dividends to family members. Split income paid from a corporation is taxed at the highest tax rate unless certain criteria are met. One of the most common exceptions is when a family member who owns shares of the corporation works at least 20 hours per week on average for the company. In this case, dividends can be paid to them and taxed to them without the punitive TOSI rules applying.

Pension Planning Strategies

Workers with pensions can split their eligible pension income with their spouse or common-law partner in retirement. However, there is a difference between defined-benefit (DB) and defined-contribution (DC) pension plans. I have found most are Defined Benefit. If you have a Defined contribution, be sure to do some research or engage us to assist you, as there are some very specific rules.

Workers with Defined Benefit pensions that receive a calculated monthly benefit in retirement can split up to 50 per cent of their pension with their spouse or common-law partner on their tax return.

CPP allows a recipient and their spouse or common-law partner to apply to split their pensions by completing a CPP pension sharing form. The CPP earned by the couple based on contributions made during the years they lived together will be divided equally between them. This may result in tax savings if there is an income differential.

RRSPs and RRIFs

RRSPs that are converted to registered retirement income funds (RRIFs) do not qualify for pension income splitting until the year the accountholder turns 65. RRSP withdrawals do not qualify for pension income splitting unless the account is converted to a RRIF either.

I generally recommend that if spouses have a significant difference in incomes, RRSP contributions should be made by the higher income spouse. RRSP deductions will reduce the higher income spouse’s income and leave the other spouse’s income to be taxed at a lower tax rate. One exception to this rule could be if the lower income spouse has a matching contribution for a group retirement plan with their employer. The benefit of the match may exceed the tax differential between the spouses.

If a couple is concerned about having all the RRSP assets in one spouse’s name, the higher-income spouse can contribute to a spousal RRSP for the other. A spousal RRSP is an RRSP that one spouse contributes to but is owned by the other spouse. The spousal RRSP owner can take withdrawals in the future that are taxable to them, subject to a three-year time limit that may cause withdrawals to be taxable to the contributor.

Non-Registered Investments

If someone has maxed out their RRSP and tax-free savings account (TFSA), there may still be income-splitting options to consider. If married, the higher-income spouse’s income can be used to fund living expenses while the lower-income spouse saves some or all of their income. By having the lower-income spouse build non-registered assets, the investment income will be taxable to them at their lower tax rate.

A higher-income spouse cannot just give money to a lower-income spouse to invest to save tax. The income and capital gains would be subject to attribution and taxable back to the gifting spouse.

Money can be loaned to the lower-income spouse to invest as long as the loan is made at the Canada Revenue Agency (CRA) prescribed rate in place at the time of the loan. That rate is currently two percent but is set to rise to three per cent in the fourth quarter of 2022.

Money can be gifted to a minor child to invest and only the income (interest and dividends) is taxable back to the parent. The capital gains, however, are not taxable to the parent and can be realized in the child’s name. If a child has no other income, capital gains between $16,962 and $28,796 can be triggered tax free each year.

Taxpayers with significant non-registered assets into the hundreds of thousands of dollars could consider establishing a discretionary family trust. By loaning money at the CRA prescribed rate to a family trust with children, grandchildren or other family members as beneficiaries, income can be shifted to those with lower incomes, some of whom may have little to no income or tax to pay.

So, you can see there are some opportunities to split income under the right circumstances.

Thank YOU!!

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  1. Income Tax Preparation
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  4. and Accounting!!

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Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.