Prescribed Loan Rate Strategy
If you pay taxes at the highest marginal tax rate, you know just how punishing Canada's marginal tax system can be. For many Canadians, taxes are their largest annual expense. But if you have family members that earn little or no taxable income, you currently have a historic opportunity to reduce your family's overall tax bill by making prescribed rate loans to family members.
Until March 31, 2015, the Canada Revenue Agency (CRA)-prescribed interest rate is at a low of 1%, creating an opportunity to maximize this proven, yet often overlooked strategy. The 1% loan rate can be locked in for life regardless of future rate increases.
Spousal Loan Strategy :
With the Spousal Loan Strategy, you make a loan to your spouse, which is backed by a simple promissory note and loan agreement setting out the terms of the loan. Then your spouse invests the entire loan amount in their own name. This way, the income attribution rules are avoided and the entire investment income is taxed at your spouse's lower marginal rate reducing your family's overall taxes. To ensure the income is taxed in your spouse's hands and not yours your spouse must pay you interest at the CRA-prescribed interest rate by January 30 of the following year (and by January 30 following the end of every subsequent year during which the arrangement continues).
Family Trust Strategy:
With the Family Trust Strategy, you establish a family trust for your younger family members (children or grandchildren). You loan money to the trust at the CRA-prescribed interest rate. The monies are then invested in the trust and all the investment income (less 1% paid to you by January 30 of the following year) can be taxed in the hands of the children or grandchildren. If they have no other income, then each child or grandchild can earn approximately $11,000 of interest income, $22,000 of capital gains or $49,000 of Canadian public company eligible dividend income tax-free every year (depending on the child or grandchild's province of residence).
By loaning the money instead of giving it, you retain ultimate control of the funds, and the investment income can be used for your child or grandchild's benefit (e.g. to pay for private school expenses, lessons, gifts, etc).
Bear in mind that CRA-prescribed rate may be different after March 1, 2015, so ask us for the latest rate.
If you own a Canadian corporation, there are a number of creative strategies to split income with family members. One such strategy, typically done in combination with an estate freeze, is called "dividend sprinkling. Although there are some attribution rules to consider, this strategy involves paying dividends from the corporation to adult children and spouse shareholders based on the growth of the corporation after the estate freeze. If the spouse or adult children had no other income, then approximately $$8,000 - $49,000 of tax-free dividends (varies based on province) could be paid to them from the corporation every year if structured properly.
It's not what you make, it's what you keep