The federal government allows spouses to split their pension income for tax purposes. This income-splitting opportunity creates some confusion about the ability of spouses to split other types of income.
The federal government allows spouses to split their pension income for tax purposes. This income-splitting opportunity creates some confusion about the ability of spouses to split other types of income.
Unfortunately, the sad but true fact is that Canadian tax law prevents most types of income splitting among spouses, with pension income splitting being a rare exception. The federal government has a complex set of rules, known as “attribution rules,” that prevent tax-advantaged shifting of assets.
The rules state that when you transfer or loan property, including money, either directly or indirectly to your spouse, then all income or loss from the property – plus any capital gain or loss on disposition of the property – will be attributed back to you.
Example
If you transfer some shares to your spouse and at a later time he/she sells them, you must report on your tax return any capital gain or loss between your original purchase price and the price your spouse received on the sale.
Canada Revenue Agency (CRA) is carefully watching spousal income splitting. The tax court case of Louis Muio involved splitting of investment income, which is not permissible under the attribution laws.
On his tax returns for 1997 to 2000, Louis Muio attributed equally to himself and his wife the interest, dividend income and capital gains from investment accounts that were in his name only. In reassessments of his tax returns for 1997 to 1999 and in his 2000 assessment, CRA attributed all of the interest, dividends and capital gains to Mr. Muio alone.
Mr. Muio appealed to the Tax Court of Canada. However, his appeal was dismissed. The Court said that while he chose to keep the investment accounts in his name only (he claimed troubles in the marriage), Mr. Muio wanted his wife to share in the burden of the resultant taxes. Since the spouse’s annual income during the period in question averaged only about $10,000, the Court felt she could not have been contributing capital to the investment accounts. Since Mr. Muio’s employment income ranged from $75,000 to $163,000 per year during the same time, the Court believed he must have funded the investment accounts. Therefore, he alone should pay the taxes on all interest, dividends and capital gains.
Splitting Pension Income
The good news in the income-splitting story is, of course, the fact that pensioners might be able to save the family some tax dollars by splitting their eligible pension income between the higher and lower income spouse.
If you are 65 or over, your eligible pension income includes:
- Lifetime annuity payments under corporate pension plans (RPPs)
- Deferred Profit Sharing Plans (DPSPs)
- registered retirement savings plans (RRSPs)
- Registered retirement income funds (RRIFs)
If you are under 65, eligible pension income includes lifetime payments under a registered pension plan (RPP) and certain other payments received due to the death of a spouse. Old Age Security and Canada Pension Plan payments are not considered eligible pension amounts.
Pension income splitting may also allow the recipient, lower-income spouse to claim the pension income credit if he or she was not already receiving eligible pension income. The federal credit is the lesser of $2,000 or 15% of the eligible pension income allocated to the recipient spouse.
Splitting pension income between spouses reduces the net income of the pension transferor while it increases the income of the spouse transferee. That is why pension splitting will affect tax credits and benefits calculated using one individual’s net income.
Optimizing your family scenario can be complex, so seek the help of a tax specialist to find the best split of pension income to produce the least tax payable and maximum tax benefits.
Read more about income splitting and the benefits of a spousal partnership in our article, Spousal Partnerships Can Reduce Income Tax Load.
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