The Canada Revenue Agency (CRA) prescribes a low income-splitting rate of only one percent, which has made it possible for some individuals to implement income-splitting strategies with their spouses, common-law partners, grandchildren, or other family members.
Splitting income is the process of transferring income from a high-income individual (who pays high taxes) to a lower-income individual (who pays lower taxes). We have graduated tax brackets in our tax system, so taxing some income from lower-income earners lowers the family’s overall tax bill.
Various income splitting theories have been floating around, among them:
- You don’t need to involve them in the business, just pay them half your salary
- Transfer funds to their joint accounts (non-joint).
- Transfer assets into their names
- They can own shares and receive dividends.
Paying A Salary To A Family Member
Paying a salary or wages to a member of the family is one of the most efficient ways to reduce a tax bill. Typically, these members can be a spouse or civil partner, or children. A spouse or civil partner may also be employed for non-tax reasons, such as earning NIC credit towards state pension entitlement or contributing to a private pension plan with an employee’s salary.
Consequences of Income splitting among paying family members
Tax savings begin with the division and rule concept. To legally become an independent taxpayer under the provisions of the income tax law, each member of the family must have an independent source of income. Families with just one member who earns all the income have a higher tax liability than families with multiple/ members who earn the same income.
Income tax law does not allow dividing income arbitrarily among family members and then paying lower taxes in their names. Gifts and settlements can, however, be used intelligently to achieve this goal.
2 Easy Ways To Slit Income
- Electing to split pension income
If you and your spouse have pension income, you can split up to 50% of it when filing your income taxes. RRSPs, RRIFs, life annuities, company pension plans, and life annuities are all included in this calculation. The age requirement for withdrawing from an RRIF is 65.
You only need to fill out one form when filing both of your tax returns. As a result, the spouse with the higher income can deduct some of the pension income from their income in the lower tax bracket so that it will appear on the husband’s or wife’s income in the lower tax bracket.
- Spousal loan
When a couple has a higher income, it can be tempting to invest money with their partner, hoping the couple will enjoy tax-free growth from their investment. It is, however, viewed by the Canada Revenue Agency (CRA) as a tax evasion method. While their spouse owns the investment account, the government will tax the higher-income earner.
A different situation arises when the money is lent to a spouse with a lower income. As long as interest rates are charged on the loan at the CRA’s prescribed rate and the loan is repaid, the lower-income spouse can invest the money the higher-income spouse lends them.
Need more advice about income splitting rules?
Before paying dividends to your spouse or anyone else in your family, it is best to seek advice from a tax professional if you have questions about income splitting.
