In the second of a three-part series exploring the 3 pillars of tax-efficient investing, we look at the important role of income splitting in your overall tax plan. Previously, in part 1, we looked at income deferral.
The basic principle behind income splitting is to reduce the overall family tax bill by shifting invested money and the income it generates away from the highest income family member to a lower income family member.
There are potential tax savings with income splitting due to Canada’s “progressive” tax system under which we pay a higher rate of tax as our taxable income increases.
While there are “attribution rules” that severely limit income splitting among family members, there still are some opportunities that might work for you depending on your particular situation.
You can use the lower income spouse’s salary and other earnings for investment purposes, resulting in the family’s total investment income being taxed at the lowest possible rate.
You also could consider making an interest-free loan to your spouse or children for investment purposes.
Under the attribution rules, income earned on investments by your spouse or child under 18 will be taxed in your hands; however, that income becomes their property and it can be reinvested without further attribution to you. Note: the attrition rules are different for adult children and children under 18.
You could loan funds to family members other than your spouse to invest in assets that will generate capital gains, which are not subject to attribution rules.
Perhaps you might be able to shift assets between you and your spouse. The attribution rules do not apply if you transfer assets to your spouse in return for assets of equal value.
If your spouse has a non-income-producing property, such as a cottage, you could purchase the property at fair market value for cash or other income-producing assets. Then, your spouse will earn the income from the cash or other assets while you both continue to enjoy the cottage.
The higher income earner might also pay taxes for the lower-income spouse, make contributions to a spousal RRSP, and allow the lower-income spouse to claim all family tax credits such as medical costs and charitable donations.