Split That Income

Posted Thursday, May 26th, 2011. Filed Under Financial Empowerment

For those who are a couple and bring your finances together, the idea of income splitting can make sense, especially from a tax standpoint.

I wanted to share an article written in the National Post on Saturday, May 21, 2011 on the topic of income splitting. The article is written by Jonathan Chevreau.

The title states: Big savings can be had by lending money to your spouse if one of you is raking in a fatter paycheque.

Chevreau says that with interest rates hovering near historic lows, there’s a historic opportunity to lock in spousal loans to split investment income for tax purposes. This income splitting strategy depends on one spouse being in a lower tax bracket than the other. This strategy is ideal for a couple where one is the breadwinner and the other is the homemaker or not paid from the workforce.

Unlike spousal RRSPs and pension splitting, which involves registered investments, spousal loans let couples split unregistered investment income. According to Canada Revenue Agency, there were 7.2 million tax filers who showed interest or investment income in 2009.

How it works is the spouse in the higher tax bracket lends the lower-bracket spouse money to buy (for example) securities, which are then taxed more favourably in the low-earner’s hands. This should be a legal, fully documented arrangement, by way of a formal loan or promissory note, that specifies the terms of repayment. It will state the interest rate sanctioned at a “prescribed rate” as sited by the CRA.

Currently the rate is 1% and may raise as early as July. When it rises it does so in 1% increments.

One of the benefits is that while the interest paid to the higher-earning spouse is taxable in their hands, it is tax deductible to the lower-income spouse.

There are 2 reasons spousal support is getting more attention:
1. low interest rates
2. know that locking in now, you can keep the low prescribed rate even if interest rates do start to soar.

We have seen interest rates as high as 14% in the early 1990s, however, rates have hovered around 1% since the second quarter of 2009.

One note of caution: you have to fund the loan to your spouse. You cannot just lend our a small fraction of it in order to lock in the low rate.

As far as the promissory note or formal loan, a lawyer or accountant can draw the agreement specifying the terms of repayment. If interest is not paid to the higher income spouse within 30 days of the end of the year, that year’s income and all future income from the loaned property will be attributed back to the lender.

One planner, Jamie Golombek, managing director of tax and estate planning for CIBC Wealth Management, says, he prefers to use fixed income investments for spousal loans. “Capital gains is only half taxable anyway, so the biggest spread will be on fixed income”.

Because 75% of tax-filing Canadians earn less than $50,000, many families with one high-bracket earner can benefit from the strategy.

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2 Responses to “Split That Income”

  1. mark on June 2nd, 2011 9:41 am

    There are many ways to split income, some of which were mentioned in the blog. Some other ways is to pay your spouse a wage that can be expensed off via a management expense, other ways are setting up a company to be deposited into at a corporate tax rate then payout to you and your spouse an income from there and write off expenses via the company, leaving your income paid out by the company at a level you both can work with. I am sure there are many other ideas, I hope this may help someone. it worked for me while i was married.

  2. Sandra on June 2nd, 2011 12:44 pm

    Thank you so much for sharing your insight.

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