We are talking about tax planning again today. People forget about the planning part after filing their taxes in 2016. If you can plan it ahead and execute it properly, it may save you a lot of money. One of tax planning strategies is income splitting.
How income splitting works
You may be familiar with the family tax cut, which was previously introduced by Harper Government. This is a good example to allow families (having minor children) to transfer income between spouses in order to receive the non-refundable tax credit up to $2,000. (Too bad, it has been discontinued starting from 2016 taxation year.) Now you have some sense about income splitting. Right?
Here is another example. Assume a couple where wife makes 120k a year and the spouse earns less than 20k, they will definitely will pay more in taxes than if another couple making 70k respectively. As Canada tax system is based on progressive tax rates, it is always beneficial to shift income from one in a higher tax bracket to the other in a lower tax bracket. In reality, the combined federal and provincial tax brackets go up to 46%, so personal tax rates increase as your income increases. Obviously income splitting helps save a lot of money if income can be shifted from the higher tax bracket to the lower one (in some provinces, it may go down to 20 %.).
Can it be planned on everyone?
It depends on your specific situation, like age, family situation, sources of income, etc. Here are some common situations.
Planning with spouse and kids
Loan to spouse
Generally, one spouse making more money can load funds to a spouse, who will invest the money later. The gain/income earned through the funds will be taxed on the spouse who borrows the money (having a lower tax bracket). As a result, money is saved as the gain/income is taxed at the lower tax bracket. One very important thing that you need to be aware is that the spouse lending the money has to charge interest as prescribed by the CRA. 1% is the rate prescribed by the CRA now. Furthermore, the interest payment check has to be cut and deposited to the lending spouse account physically. Otherwise, the CRA may deny the income splitting and the gain/income would be taxed on the lending spouse with the higher tax bracket.
Pay dividends to kids
When kids hold certain classes of shares of the family business (corporation), they can be paid through dividends. Dividends are after-tax dollars. So they don’t reduce income from corporate tax perspective. However, it is beneficial to split the dividend income with other family members as the overall tax obligation will be reduced.
Pay salary to kids
How about paying kids with salary? Yes, it is a good idea when kids have done reasonable amount of work in the business. As a result, the overall business income is reduced accordingly. As a result, the overall tax for the families is reduced as well. Mind you, the salary must be reasonable for tax purpose. Otherwise, it can be challenged by the CRA and finally gets denied.
Pay dividends to kids through a family trust
A family trust can also be used to avoid the potential matrimonial issue.
Planning with elders
You may plan income splitting with the elderly parents where the opportunities exist. For example, parents can baby-sit kids while the spouse can focus on developing their careers. Then the spouse pays the parents the market rate for the baby-sitting service. As a result, the spouse can reduce their overall income by claiming child-care expenses which are paid to the grandparents. Sounds good, doesn’t it? But you need to watch grandparents’ income level. If they are receiving Old Age Security pension, there might be a claw back on the OAS payments if their net income for the year exceeds a certain annual threshold. For 2015, the threshold is $72,809. Some other factors are needed to be considered as well, like nursing homes who are looking at the level of income for eligibility as well.
A common income splitting technique for elders is that you can file a pension splitting election so that you can split certain forms of pension income (RRSP, RRIF, etc.) with your spouse. However, this election does not apply to CPP. For CPP, you can share your Canada Pension Plan retirement pension with your spouse through sending the application. This may result in tax savings as well.
Conclusion
Above we have briefly touched the income splitting strategies. There are many other income splitting strategies available. As long as you play within the rules, you should have no worry and enjoy the tax savings resulting from income splitting strategies. However, if situations get complicated, please make sure to check with professionals in order to assess the impact.
If you have any accounting/tax questions, drop us a line or give us a call. We surely can help!
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