Make sure both spouses will have same
annual income when they retire.
Why split income with a spouse?
By splitting income with a spouse, the higher income
taxpayer can reduce net income and
taxable income. The benefits of this include
reducing the taxpayer's marginal
tax rate (and possibly increasing the spouse's marginal rate)
reducing or eliminating OAS clawback
creating a pension tax credit for the spouse (with pension
splitting)
If both spouses are in the same tax bracket, income
splitting will not provide the benefit of a reduction in the marginal tax
rate. However, pension splitting may still be useful if it creates
or increases a pension
tax credit for the spouse.
Canadian tax laws allow you
to put funds into either your own RRSP or a spousal RRSP. If neither spouse will have a pension from their employment when
they retire, then both spouses should try to have the same amount in
RRSPs. If one spouse will have a pension, then the other spouse should
have a greater amount in RRSPs.
When funds are
contributed to a spousal RRSP, the spouse making the contribution gets the
deduction from income when the contribution is made. However, if the
funds are withdrawn within 3 years of the contribution, the withdrawn amount
will be taxed as income to the spouse who made the contribution.
Tax
tip: Try to ensure both spouses will have
approximately the same annual income in retirement.
Split income
by employing your spouse or child.
If you are self-employed, you can employ your
spouse or your children. The spouse or children must be paid a reasonable wage for services
performed. See also Don't
pay unnecessary unemployment insurance premiums on our
Small Business page.
Lend money
to your spouse or child.
Income Tax Act s. 74.5(2), Income Tax Regulations s.
4301(c)
If one spouse is in a higher tax bracket, it may be beneficial to lend
money to the lower-income spouse. Money can also be loaned to a
child. The funds can be used to purchase investments,
and tax on
the investment income will be paid by the lower-income
spouse at a lower marginal rate. A promissory note should be
written for the loan, with the interest rate and principal amount
specified. Interest must be paid on the loan by January 30th of each
year. The interest rate charged must be greater than or equal to the
prescribed rate set by Canada Revenue Agency (CRA) at the time the
loan is made. The prescribed rates are subject to revision
each calendar quarter, and can be found on the CRA prescribed
interest rates page. The rate to use is the one for calculating
taxable benefits from low-interest and interest-free loans to employees and
shareholders. This rate was increased from 2% to 3% effective October
1, 2004.
The interest received by the lender must be included in income, but is
deductible as carrying charges by the borrower.
Example:
Mr. A earns $80,000 per year, and has a marginal tax
rate of 40%
Mrs. A earns $34,000 per year, and has a marginal tax
rate of 25%
Mr. A has accumulated savings of $100,000, he and Mrs.
A have no debt, he has used his maximum RRSP
contribution room, and he would like to purchase
investments outside of RRSPs.
Mr. A lends the $100,000 to Mrs. A on January 1, 2005.
A promissory note is written up, specifying that the
loan is made at the current prescribed interest rate of
3%.
Mrs. A invests the $100,000 50% in Government of
Canada bonds yielding 5%, 50% in Canadian stocks
yielding 10% (2% dividend, 8% capital gain).
Bond interest income of $2,500 in 2005 is reported by
Mrs. A on her 2005 tax return.
Canadian dividend income of $1,000 in 2005 is reported
by Mrs. A on her 2005 tax return, which adds $1,250 to
her income because Canadian dividends are grossed-up by
25% to include in income.
Mrs. A pays $3,000 (3%) interest expense to Mr. A on
December 31, 2005. This interest expense is
deducted on line 221of Mrs. A's 2005 tax
return.
Mrs. A's taxable income is $34,750 (34,000 + 2,500 +
1,250 - 3,000).
Mr. A includes the $3,000 interest income on line 121
of his 2005 tax return.
Mr. A's taxable income is $83,000 (80,000 + 3,000).
Approximately $110 in tax is saved by Mrs. A investing
the $100,000 instead of Mr. A, assuming the Canadian
stocks are not sold, so there is no capital gain
included in taxable income. If the Canadian stocks
are sold and 8% capital gain realized, approximately
$300 in tax is saved. If Mrs. A has no income
other than the investment income, the tax saved changes
to approximately $55 with no capital gains, and $410
with capital gains.
Disadvantages:
The interest on the loan must actually be paid by Mrs.
A to Mr. A by January 30th of each year, or the income
from the investments will be included in Mr. A's
income.
If Mrs. A has capital losses from her investments, the
interest still must be paid (although Mr. A could gift
Mrs. A the funds to pay the interest).
Very little tax is saved even when $100,000 is
invested.
Tax tips:
- Maximize RRSPs
(especially spousal for the lower income spouse)
- Carefully check
your own circumstances, and get professional advice
- The lending to
spouse strategy saves very little tax if $100,000 or less is
invested.
Have the lower income spouse invest all earnings
If both spouses are earning income, but one is in a much
higher tax bracket, the lower income spouse could invest all
earnings, while household and other expenses are paid by the
higher income spouse.
The information on this site is not intended to be a
substitute for professional advice. Each person's situation differs, and
a professional advisor can assist you in using the information on this web
site to your best advantage.
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