Income splitting is the shifting of income from one individual who has a high tax rate to another person who has a lower tax rate. This is often done between spouses but can also be used between common-law partners and parents and their children. Income splitting has the potential to provide Canadians with a high amount of tax savings.
If you made $60,000 in the last year you would pay $15,500 in income tax. However, if you made $30,000 and your spouse made $30,000 you would each only be taxed $5,500, making the total tax bill $11,000, that’s $4,500 cheaper then if you were taxed on your own.
However, income splitting is not as simple as it may seem. The CRA has many rules and regulations in place surrounding income splitting. Attribution rules tend to nullify many attempts to reduce your taxes. Here are a few ways these rules will impact your attempts to transfer your funds:
- Gift Money: All investment income (interest, dividends, rents, and royalties) and capital gains will be attributed back to you.
- Loan Money with no Interest: All investment income (interest, dividends, rents, and royalties) and capital gains will be attributed back to you.
Let us take you through some of the common ways that you can split your income, they often take sifting through a large amount of red tap but financially are often worth it.
Canadian Pension Plan Sharing
If both you and your spouse are above the age of 65 then you can potentially split your CPP 50%-50%. How much you are able to transfer to your significant other depends on factors such as how long you have been together. This is not technically considered income splitting but it is roughly the same idea.
Other Pension Splitting
As of 2006, the CRA announced that a variety of pension incomes could be split. There is no age limit for the person who is receiving the split pension but the person who is giving the pension much be over 65 in most circumstances. The CRA provides the following example:
Stu is 65. He worked his whole life at an insurance company and has saved for retirement through RRSPs. He is also receiving payments from a registered pension plan. Annabelle is 59; her income is not as high as Stu’s. For Stu to split his pension with Annabelle they need to have been married or in a common-law partnership at the end of 2013 and they have to be residents of Canada at the end of the year.
Then, they have to have eligible pension income. What’s eligible? Most pension and superannuation payments qualify, so Stu’s life annuity payments from his pension plan can be split between him and Annabelle. Annuity payments are fixed sums you receive annually or periodically throughout the year. Since Stu is over 65 at the end of the tax year, annuity payments from his RRSP and most amounts from a registered retirement income fund are also eligible. If Stu was under 65 but was receiving them due to the death of a former partner or spouse, these kinds of payments would still be eligible.
The eligible amounts, added together, make up the pension income that Stu and Annabelle can split. Stu and Annabelle then fill out form T1032 and indicate how much Stu will be deducted from his pension income, and how much Annabelle will be including in her income.
In order to use this tactic, you must charge interest on the loan. The interest must be at least equal to the CRA prescribed rate. The interest received on the loan has to be reported as income by the lender of the money.
For you to end up with a lower overall tax bill between the two of you, the money you lend your spouse has to make a return greater than the prescribed rate – and you have a really good chance of your investment doing this with a prescribed rate as low as it is.
Hiring your spouse or child:
This works well if you own your own business. You can pay your partner of children and therefore part of your income is going to them as wages. They have to actually work for you and you have to pay them a reasonable wage for a real job. All work must be documented and there are strict regulations in place to prevent abuse of the program. You can pay a child that has no other income up to $3,500 a year without generating a tax bill for that child. If you pay the family member more than $3,500 up to $11,137 you have to pay CPP contribution only. If you pay the person more than $11,137, they would have to pay CPP and taxes for their earned income.
In order to ensure that both spouses have equal income during retirement, the higher-earning spouse may have to contribute to their partners' RRSP. Contributing to your spouse's RRSP makes sense because unlike the other forms of pension splitting there is no age limit. In the future, your spouse will withdraw the funds from their RRSP and pay the taxes on that withdrawal.
You can place in tax-free savings account for your lower-earning partner or adult children. See the limits for the contributions.
Navigating through the CRA restrictions on income splitting can be tricky but as seen from our example, extremely cost-effective. Contact our team today at nicole@cpaforcanada to help steer you in the right direction.