INCOME SPLIT OPPORTUNITIES*

February 25, 2022

Given that we are in tax season, I would like to share some ways to reduce family taxes that I have learned about in my finance courses. As always, consult with your accountant if you would like to try anything mentioned below.

Income Splitting Opportunities

What is income splitting? It’s moving income from a family member in a higher tax bracket to a family member in a lower tax bracket with the goal of lowering the overall family tax bill. To note, in Canada, if a spouse gives income or stocks or real estate to another spouse, the “giver” will continue to pay taxes on those items. This is called: attribution rules.

However, there are a few exceptions where income splitting is allowed:

• TFSA contribution: You can provide funds to your spouse or children older than 18 to contribute to their own TFSA’s. TFSA’s are not subject to the attribution rules.

• RRSP contribution: Different from the TFSA, a person can contribute to a spouse’s RRSP but only up to the person’s maximum RRSP contribution. In other words, if my RRSP contribution for the year is $10,000, I can choose to put it in my own RRSP, my spouse’s or split it between the 2. However, I don’t gain any additional contribution room by doing that. The only benefit is when the RRSP is withdrawn, it will be taxed in the hands of the RRSP owner. If the current CRA rules remain, this strategy is not as helpful as there is another way that RRSP withdrawals can be taxed in the spouse’s hands called split pension income (see below)

• Split pension income: If you’re 65 years or older, you can split up to 50% of eligible pension income with your spouse or common-law partner. Although it’s called “pension income” it also applies to: RRSP, RRIF, Deferred profit sharing plan, Lifetime annuity payments.

• Prescribed Rate Loan: is a loan between you and your spouse or a child older than 18. The CRA requires that you charge interest on this loan at the “prescribed rate”. The prescribed rate is determined by the CRA and is updated every quarter. Right now, the prescribed rate is at its lowest: 1%, and it will likely go up once interest rates increase.

So, when is this a good strategy? When a family member is in a significantly lower tax bracket (or has no income), he/she can take a loan from the other spouse or parent and invest it in the market. With that, any capital gains, interests, dividends will be taxed at the lower income person’s tax bracket.

The interest rate on the loan will remain the same as when it was taken (even if the prescribed rate goes up). Hence, now that is at 1% seems like a good time.

Requirements:

• The family member that borrows the money must pay the interest to the other spouse or parent before January 30th of each year while the loan stands.

• The spouse/parent lending the money declares the interest income on their tax return. However, the family member borrowing the money can deduct the interest in their own tax return. Although it’s not a complete wash, the amount of taxes paid for the interest in total should be relatively small.

• A loan agreement should be signed and filed. Click for more information on prescribed rate loans as well as a sample of the agreement

I have been interested in trying a prescribed rate loan since I left my corporate job and I am thus in a lower tax bracket. However, since I have been very skeptical about investing in the market, I had stayed away from it.

Given my recent analysis about investing in stocks inside RRSP’s (see last month’s post, here); I decided to sell some stocks in my RRSP, and set up a small spousal loan from my husband to buy them in a non-registered account. All that to say, I’m new to this strategy and happy to share any learnings in the future.

To note, there is another way for the lower income spouse to be the one investing in the market. It is through splitting Expenses vs. Investments. It works by having the spouse in the highest tax bracket pay for all, or most, of the home expenses and the spouse in the lowest tax bracket, after paying for any remaining expenses, uses any additional dollars for investing. That way, capital gains, interests, dividends of the investments will be taxed at the lower income tax bracket. It’s important to keep good records (maybe even separate bank accounts) in case you ever have to prove to the CRA

Claudia Soler

* Disclaimer: The information contained within this blog is for informational purposes only and it is not intended as a recommendation of the securities highlighted or any particular investment strategy; nor should it be considered a solicitation to buy or sell any security. In addition, this information is not represented or warranted to be accurate, correct, complete or timely. the securities mentioned in this blog may not be suitable for all types of investors and the information contained in this blog does not constitute advice. Before acting on any information in this blog, readers should consider whether such an investment is suitable for their particular circumstances, perform their own due diligence, and if necessary, seek professional advice.