Income splitting is the process of moving income from a high-wage earner to a low-wage earner. This strategy takes income out of top or middle tax brackets and shifts it to lower tax brackets. This ultimately allows a family to reduce tax liability and save money. The Canada Revenue Agency doesn’t allow taxpayers to split income with other relatives, but there are exceptions to this rule as well as alternative income-splitting strategies you may wish to explore.
Pension Income Splitting
If you have pension income, you may split up to 50 percent of that income with your spouse. For example, if you have $50,000 in qualifying pension income, you may shift up to $25,000 to your spouse.
Regardless of your age, you may split the taxable portion of life annuity payments from a superannuation or pension fund. If you are over the age of 65, you may split payments from registered retirement income funds, registered retirement savings plans and qualifying amounts from retirement compensation arrangements. However, if you receive those types of payments due to being a widow, you may split them with your spouse or common-law partner even if you are not 65 yet.
If you earn more than your spouse, you may want to make all of the family’s retirement contributions. That reduces your income and the amount of tax you owe, compared to your tax liability if you and your lower-earning spouse make the same retirement contributions. When you contribute to your spouse’s RRSP, the income is in your spouse’s name upon retirement, which is another form of income splitting.
Self-Employed Individuals and Business Owners
If you are a freelancer, a self-employed person or a business owner, you may pay your spouse or children income from your business. However, you cannot pay your family members for doing nothing, and you must pay them a similar salary as you would pay a person at arm’s length from you.
Similarly, if you and your spouse or common-law partner run a business together, you should register the business as a partnership and report your earnings accordingly. For example, if you own 60 percent and your spouse owns 40 percent, you report 60 percent of the earnings while your spouse reports 40 percent of the earnings. If only one of you reports all of the earnings, your tax burden will be unnecessarily high.
Family Loans for Investments
You may loan money to a relative to buy investments. If the investments grow, you can split the earnings. However, you must charge at least 1 percent interest, and you can give your relative the loan directly or through a trust.
The Family Tax Credit
In the 2016 Budget, the Canadian government announced the elimination of the income splitting tax credit. Worth up to $2,000, this credit simulated the tax savings that would occur if a higher-earning spouse transferred $50,000 of income to a lower-earning spouse. You may be able to claim this credit if you are filing a 2014 or 2015 tax return.