The Canadian tax system taxes individual, rather than family, incomes. That means that if you’re married, or living in common law, you might want to consider a transfer of income to a lower-earning spouse or children.
Known as income splitting, this tactic can significantly trim your tax burden because the income transferred is taxed at the marginal rate of the lower-income family member.
However, from the government’s perspective, income splitting means less revenue. So tax authorities put up some obstacles called attribution rules. Under these provisions of the Income Tax Act, certain income earned by related parties is attributed back to the person who made the transfer.
Nevertheless, there are legal ways to split income. Here are five methods that might help you save on federal taxes:
|Gifts to a spouse. If you provide any gifts or interest-free loans to your lower-income spouse, dividends, capital gains or interest earned will be attributed back to you. However, if your spouse reinvests the investment income, the money earned on those investments is taxed at your spouse’s lower rate.Transfers to children. All income derived from gifts to an adult child are taxed at the child’s rate rather than yours. With an interest-free loan, and under attribution rules, income earned on the funds will be taxed in your hands, just as it would have been if you had not made the loan. However, the income then becomes their property and can be reinvested without further attribution.
Trusts. Starting Jan. 1, 2016, graduated tax rates will apply to testamentary trusts for the first 36 months. After that it is taxed at the highest marginal rate except where there is a disable beneficiary. The rules are complex. Consult with your accountant.
Retirement plan transfers. Income derived from a contribution to a spouse’s Registered Retirement Savings Plan (RRSP) is not attributable to you if the money stays in the plan for at least two years. The point of making contributions to a spousal plan is to provide tax relief at retirement. Spouses with equal RRSP funds when they retire will likely pay less in total tax.
Pension Splitting. Anyone who is eligible for the Pension Income Tax Credit can transfer as much as 50 per cent of the qualifying income to the tax return of a lower-income spouse or common-law partner. This is generally allows a greater portion of family income to be taxed at a lower rate and generates a higher level of after-tax income.
Registered Education Savings Plan. You receive no tax deduction at the time of your contribution to the plan and all income earned within the plan is reinvested tax-free. When the plan starts paying out for the education of children or grandchildren, the money withdrawn is taxable to the student, who is likely to be in a low marginal bracket.
Caution: Provincial rules vary in terms of tax rates and the ability of minors to enter into contract agreements. Attribution rules are complicated, so consult with your accountant before you start splitting your income.