Financial Focus: Two reasons to embrace family income splitting
By Medicine Hat News on January 5, 2019.
There are two reasons why income splitting in Canada can reduce the family’s tax burden: 1. Canada’s tax system is based on graduated tax rates; and 2. Everyone in Canada has a tax-free basic exemption amount. A graduated tax rate system basically means that the tax rate increases as taxable income increases. Furthermore, each Canadian resident can earn taxable income every year, tax-free, due to the basic personal tax credit. 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 multiplied tax savings by using the basic personal tax credit of each member of the family. Due to this amount of potential annual tax savings, families earning a high income should strongly consider family income-splitting strategies. In order to prevent abusive income-splitting arrangements, the Income Tax Act has income attribution rules. These rules will attribute certain types of taxable income back to the high-income family member that actually supplied the capital for investment, thus achieving no tax savings. For business owners, you 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. If you own a Canadian corporation, there still is the ability to split income with family members but they come with tests and restrictions under new rules. There is what are called TOSI rules — Tax On Split Income. These rules depend on a number of different factors such as age or ownership structure so it is best to review the changes to these rules with your tax professional. A common investment income-splitting strategy with a low-income spouse is the prescribed rate loan strategy. A high-income spouse loans capital to a low-income spouse for investment at the CRA-prescribed interest rate. All future investment income will be taxed to the low-income spouse, provided the low-income spouse pays the high-income spouse interest annually. The high-income spouse must declare the interest on the loan. Gifting funds to minor children and earning capital gains on the funds is still an effective income-splitting strategy that many high-income parents with low-income children should consider. A child with no other income can earn a certain level capital gains income every year tax-free (varies by province) due to their basic personal exemption. If you are concerned about gifting monies to your child outright, then consider loaning the funds to a family trust on an interest-free basis. 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. Again, rules around income splitting do change and you should review your options with your tax professional. A. Craig Elder, CFP, FMA, CIM, FCSI, is a Vice-President, Portfolio Manager and Wealth Advisor with RBC Dominion Securities Inc. in Medicine Hat. RBC Dominion Securities is a member of the Canadian Investor Protection Fund. Information provided by RBC Wealth Management. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. For more information on this and other financial strategies, contact Craig at 403-504-2723. 12-11
