Strategy 9 – Family income splitting
Reduce your family’s tax burden
There are two reasons why income splitting is so important in Canada to reduce the family’s tax burden:
- Canada’s tax system is based on graduated tax rates
- Everyone in Canada has a tax-free basic exemption amount
A graduated tax rate system basically means that there is a higher marginal tax rate on taxable income as income increases. Furthermore, each Canadian resident can earn about $10,000 (varies by province/territory) of taxable income every year tax-free due to the basic exemption amount. As a result of these two factors, if income can be shifted from a high income parent to a low-income spouse or child, then the family can realize tax savings annually by shifting income.
In order to prevent abusive income splitting arrangements, the Income Tax Act has income attribution rules. These rules attribute taxable income back to the high-income family member who actually supplied the capital for investment; thus the income splitting will achieve no tax savings.
Business owners can split income by paying reasonable salaries to lower-income family members based on the services they perform. However, if a low income spouse or child is not actually working in the family business or their services are minimal, then paying them a salary or bonus that is in excess of the services rendered simply for income-splitting purposes is not permitted.
Business owners can split income by paying reasonable salaries to lower income family members based on the services they perform.
If your business is incorporated, you may be able to pay dividends to family members who are shareholders of the corporation, but you have to be aware of the tax on split income (“TOSI”) rules, which limit splitting certain types of income with family members. Speak to a qualified tax advisor to determine if this strategy is right for you.
A common strategy to split investment income with a low-income spouse, whether you own a corporation or not, is the spousal loan strategy. With this strategy, the high-income spouse loans capital to the low-income spouse for investment at the CRA prescribed interest rate in effect at the time the loan is made. In this case, all future investment income is taxed to the low-income spouse. However, the high-income spouse must declare the interest received on the loan as income on their tax return.
Although capital gains income earned on funds gifted to a minor child may not trigger the income attribution rules, interest and dividend income earned on funds gifted to a minor child will be taxable to the parent. It may also be difficult to set up an investment account for a minor.
Your family’s overall income tax bill can be reduced through the effective use of income-splitting strategies such as the spousal loan strategy, a prescribed rate loan to a family trust, spousal RRSPs and pension income splitting.
If you are concerned about gifting monies to your child, consider loaning the funds to a family trust using a prescribed rate loan. This will accomplish the same capital gain income-splitting benefit as an outright gift if the trust and loan are set up properly, and you can call back the loan principal any time.
Further, with a prescribed rate loan all future investment income, including interest and dividends and capital gains, may be taxable to your child. The parent must declare the interest on the prescribed rate loan.
Speak to us if you require more information on family income-splitting strategies or would like to set up a family trust.