Income splitting is a hot topic these days, especially since the Federal Government changed the rules as of January 1.
The change affects those who own a corporation and limits the ways that business owners can distribute income. Click here for more information on the changes.
The good news is that there are still three ways that income can be split, including pension splitting, which was introduced a few years ago and income splitting with children. However, I haven’t seen the second done in ten years of practice and I wouldn’t be surprised if legislation is introduced to prevent this.
Click here for more information on those two options.
The option I’d like to discuss in detail is behind door number three: income splitting income from salaried work. It’s a way for high net worth couples to save tax, and it’s legal.
Family Loans
Say for example, you have John and Jane Smith. John makes $10 million per year and Jane is a stay-at-home mom. The logical thing to do for them to save on tax is for John to declare his salary as income and put their investments in Jane’s name to let her declare the investment income. However, the CRA says you can’t do that: Jane doesn’t earn the money for the investments so the CRA takes the income from their investments and adds it to John’s tax return, which makes sense because John earned the money.
The legal workaround to this is for the spouse earning a salary to loan the money to the stay at home parent at the prescribed interest rate. For many years, this didn’t actually benefit people because the high interest rate negated any investment income. A few years ago, the prescribed rate dropped to 1%, which made this option more attractive. Now you can loan your spouse $1 million at 1%. They declare those gains and the loaning spouse just shows the interest income.
The caveat is that the CRA wants you to have a formal loan agreement and the interest must be paid by January 30th of the following year. The CRA also wants to see the payment – a transfer of funds from one personal account to another or a cut cheque.
It’s one of those things that if you dot your I’s and cross your t’s, you can do it.
If you have questions about income splitting, please get in touch.