Income Splitting

This post we will discuss Income Splitting, and how it can benefit a lot of families out there in reducing taxes. This strategy is being used more and more these days, as more people are becoming educated on this topic.

What is Income Splitting?

Here is a definition that I found to be very straight forward and easy to understand.

Income splitting is a strategy of shifting income from a higher income taxpayer to a lower income tax payer in order to reduce the overall tax paid by the group. The Canadian tax system is progressive and the rate of tax increases as income increases. Therefore, tax payers in Canada are motivated to split income between one another.

(Source: http://blog.taxresource.ca/what-is-income-splitting-in-canada/)

The above paragraph pretty much says it all, but we will get into a little more detail on how it can be used and what some of the advantages are. There are several ways to split income (properly) and we will discuss them below. Remember, the goal for income-splitting is to ensure that both spouses will have the same (or almost the same) annual income when they retire.

1. TFSA - As of January 1, 2009, the Canadian Government introduced the new Tax Free Savings Accoung in Canada. This is now one of the easiest ways to reduce taxes for a couple. This account can be specifically used to split income. The higher income spouse can give funds to the lower income spouse (as a gift) to put into a TFSA. Any income earned is tax-free, as well as any redemptions made from the account.
2. Spousal RRSPs (which I will discuss in my next post) - The higher-income spouse can directly contribute into a Spousal RRSP in the name of the lower-income spouse. Essentially, the couple might want to aim for having close to equal value in both RRSPs at retirement, so that both income streams will be about the same. (However, this might reduce government assistance to the lower income spouse during retirement)
3. Lending Money To your Spouse - This kind of speaks for itself. The higher-income spouse can 'lend' money to the lower income spouse at a prescribed interest rate (stated by the CRA). The lower income spouse can then invest those funds, and will then pay taxes (at a lower rate) on the income earned from that investment. The lower-income spouse must pay back the interest to the other spouse before the end of the tax year.
4. Asset Shifting - This strategy is just a 'swapping' of assets between both of the spouses. For example, the lower-income spouse has an asset that is not generating him any income (like a cottage). He can then swap that asset with an asset owned by the spouse that is producing income (asset must be of equal value).
5. Paying household expenses - The higher-income spouse can just pay all the household expenses (such as gas, hydro, cable, phone etc...), as well as the lower income spouses taxes, directly from their pocket. This will then allow the lower income spouse to invest the available cashflow and pay a lower rate then the higher income spouse would if they invested the money themselves.
6. Pension Splitting - This can be done with a spouse or common-law partner. There are also several rules as to how this can be done, but the idea behind this is the same -- to lower the overall taxes paid. Also be aware of age restrictions on this strategy as well.
7. Having your own business - This one can get a little tricky, and it is best to consult a tax professional when doing this. Tax write-offs are a business owners best friend! Also, if you are self-employed, you can employ your spouse or children, and pay them a reasonable wage.

As you can see, there are several strategies that can be implemented. Each have their pros and cons (which I have not gone into) and should be thoroughly understood before they are implemented. I am not a tax professional, therefore I haven't given too much detail on these strategies. Please consult your tax professional before making any decisions on which strategy to use, and also make sure you understand the benefits and drawbacks (if any) for every strategy.

I hope you've learned something in this post. If you have any questions, please do not hesitate to contact me!