Your Money: Family income splitting basics

By medicinehatnews on September 14, 2019.

Income splitting is a tax planning technique which results in income being transferred from a high income earner to a family member in a lower tax bracket, thereby decreasing the overall tax burden to the family. Although income splitting with family members is an acceptable tax planning method, the attribution rules contained in the Income Tax Act restrict the ability to split income.

These rules were designed to prevent taxpayers from transferring assets between family members in an attempt to reduce taxes. Under the income attribution rules, income earned on capital that has been transferred (as a gift/loaned) will be attributed back to and taxed in the hands of the transferor.

There are many income splitting opportunities available also. We will discuss a few here in this column. The first is contributing to a spousal RRSP. Contributing to a spousal RRSP offers future tax benefits because it provides an opportunity for partners to equalize income during retirement. Spousal contributions can be made by the higher earning partner to a plan where withdrawals will be taxed in the hands of the lower-income partner. Contributions need to remain in the spousal plan for at least three years otherwise attribution rules will apply and the amount withdrawn will be attributed back to the contributing partner. However, Registered Retirement Income Fund (RRIF) withdrawals are not subject to the attribution rules in the year of contribution or the two previous years as long as only the minimum amount is withdrawn. Please note that the minimum RRIF withdrawal in the year of conversion is zero, and no benefit will be derived from spousal RRSPs if at retirement both parties are in the top tax bracket.

Another income splitting opportunity is called the “Prescribed rate loan.” Under this strategy, the higher earning partner loans money to the lower-income partner at Canada Revenue Agency’s prescribed interest rate at the time the loan is made. As long as a formal loan agreement is executed, and interest payments are paid within the required timeline, attribution will not apply. All income and capital gains earned from this loaned money will be taxed in the hands of the lower-income partner. The lower-income partner will deduct the interest paid while the higher income partner will report interest income on the loan; however, this should be offset by the greater return generated on the money in the hands of the lower income partner.

If the deadline for the interest payment is missed, all of that year’s income and all future years’ income will be attributed back to the lending individual. Please note that attribution does not apply to business income; therefore loans to a partner which are used to finance a business will not be attributed back to the partner that provided the loan. Also note that for tax purposes, the interest paid on the loan may be considered tax deductible.

Due to the complex nature of the attribution rules briefly discussed in this column, consider speaking to your certified financial planner and tax specialist prior to implementing any of these tax-planning strategies.

For a further discussion around your retirement and investment planning strategies, please contact me, Neil Mardian, CFP, FSCI, CIM, M.Sc. (Mgmt) 403-504- 3026

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