Loans to lower income spouse can pay off
Income splitting is a tax planning strategy which involves
reallocating income among family members to reduce the total
tax paid by the family unit. The idea is to shift some income
from someone in a high tax bracket to someone in a lower tax
bracket.
The degree to which you can reallocate income is restricted
by the government’s income attribution rules. For example,
suppose you are in a higher tax bracket than your spouse so
you decide to give money to your spouse to invest and earn
income at their lower tax bracket.
The problem is, under the income attribution rules, income
earned on capital that has been transferred by gift may be
attributed to the one who made the gift. So even though it
would be your spouse’s investment that is earning the
income, it would be taxed as if in your hands.
There is a way to avoid the income attribution rule in this
situation. Rather than gift the money or loan it without charge,
you could loan the money and charge the prescribed rate for
such loans. This way, when your spouse invests the money,
the income from the investment would be taxed in their hands.
There are a few conditions. You would have to declare the
interest income on the loan but this income should be less
than the income earned by the investment made by your spouse.
The difference on these two amounts is the amount taxed in
the hands of the lower-income spouse
In addition, you must have a formal written loan agreement
and payments of interest must be made each year or by January
30 of the following year. If the interest payments are not
made within this time limit, the attribution rule will apply.
An investment strategy to help reduce taxes
Another simple but very beneficial strategy is to use the
income of the higher earning spouse to pay living expenses
and tax liabilities and use the income of the lower earning
spouse to make investments. This way, investment income earned
will be taxed at the lower earning spouses’ rate.
Important information about our financial planning services can be found at the bottom of our
homepage.
|
