5 ways to split income with your spouse — and pay less tax
Diverting income to a lower-income spouse can effectively reduce a couple’s combined tax bill. However, it’s important to be aware of the “attribution rules” contained in the Income Tax Act. These rules deny certain types of income splitting techniques. For example, if you transfer property to your spouse, any income from the property will be attributed back to you, the transferring spouse, and must be reported on your tax return. However, there are perfectly legitimate ways to split income with your spouse without attracting attribution. Perhaps one or more ways may apply to your situation.
1 Pension income splitting
When you are 65 or over, you can split up to one-half of eligible pension income with your lower-income spouse. Eligible income includes payments from a:
- Registered Retirement Income Fund (RRIF);
- Life Income Fund (LIF) or Locked-in Retirement Income Fund (LRIF);
- Registered pension plan; or
- Lifetime annuity.
When you are under 65, only lifetime annuity payments from a registered pension plan are eligible for income splitting.
2 Spousal RRSPs
The above pension income-splitting rules were introduced in 2007, causing many Canadians to wonder whether spousal Registered Retirement Savings Plans (RRSPs) were worth keeping or starting. In fact, there are still situations where spousal RRSPs are beneficial.
For example, if you retire before 65, you can still split income using a spousal RRSP, as withdrawals can be made at any time. Just be aware of the three-year attribution rule. If your spouse makes a withdrawal from the spousal RRSP within three calendar years of your last contribution, the withdrawal is treated as income on your tax return.
Also, if you wish to split more than the one-half of pension income allowed under pension income-splitting rules, a spousal RRSP gives you that opportunity.
3 Spousal loans
In this strategy, the higher-income spouse lends an amount to the lower-income spouse to invest in a non registered account. The government sets a prescribed rate for such loans, which is currently 1% — the lowest rate it has ever been. Tax on investment income is paid at the marginal rate of the lower-income spouse.
Just be sure that interest on the loan is paid within 30 days after each year end, or the arrangement will be considered invalid. Also, before implementing this strategy, it’s prudent to seek independent family law advice.
4 Lower-income spouse invests
This strategy results in the couple’s investment income being taxed at the marginal rate of the lower income spouse. All that’s required is for both spouses to be earning income, and for each spouse to have a separate bank account.
Quite simply, the higher-income spouse pays the household bills and expenses, enabling the lower income spouse to invest his or her own funds in a non registered account.
5 Spouse as employee
If you are a business owner or self-employed, you can reduce your taxation by hiring your spouse. The job must be legitimate and you must pay a reasonable salary. You are paying your spouse with taxable income, but it is now in the form of salary that will be taxed at your spouse’s lower marginal rate. Also, since salary is a deductible business expense, you reduce the income tax your business pays.
Please contact us and seek professional tax advice if you think you may benefit from any of these income splitting strategies.