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tax matters

The attribution rules in our tax law are designed to prevent you from simply transferring certain types of income from one family member to another who has a lower tax rate.Francesco Ridolfi/Getty Images/iStockphoto

Some of my readers may recall the old church-bulletin chestnut: "Ladies, don't forget the rummage sale next Saturday. It's a chance to get rid of those things not worth keeping around the house. Don't forget your husbands." Perhaps you're a woman who believes that her husband's best-before date is quickly approaching, or is past. Let me encourage you: Your husband has more value than you might think. Even if he's not handy with tools, forgets your anniversary with regularity and can't remember the garbage day schedule, it's still true that he can bring tax savings to your family as you split income with him. So, keep him around. Now, let's talk about this concept of income splitting.

Tax savings

When it comes to saving tax, you should be concerned not only about your own tax bill, but about the total taxes you pay as a family. You can reduce the family's tax burden by moving income from the hands of one family member who will pay tax at a higher rate, to another who will pay tax at a lower rate. This is called income splitting.

Here's an example. Suppose Ned will earn $120,000 this year, including $10,000 in investment income. His wife, Judi, will earn $20,000. Ned will pay $33,409 in taxes on his income this year, and Judi will pay $1,314, assuming they live in Ontario. Their total tax bill is $34,723 combined. Now, suppose we can move that $10,000 of investment income from Ned to Judi to be taxed at her lower rate. Their combined incomes remain unchanged, but Ned's tax bill will now be $29,068 and Judi's $3,518, for total taxes of $32,586 – a full $2,137 less than before.

Here's another example. Janice will earn $120,000 this year, including $50,000 of pension income from her employer. Her husband, Peter, will have $20,000 of income. They're both over the age of 65, living in Ontario. Their total tax bill combined will be $33,898. If Janice transfers to Peter half of her pension income, or $25,000, their total tax bill becomes $28,734. They save $5,164 in taxes every year.

The rules

Here's the challenge: The attribution rules in our tax law are designed to prevent you from simply transferring certain types of income from one family member to another who has a lower tax rate. If you're caught under these rules, you – and not your lower-income family member – will pay the tax on the income. The attribution rules differ depending on who you're trying to split income with, and the type of income. Here's the low down:

  • Your spouse. If you try to split income with your spouse, either by gifting cash or assets to your spouse so that he or she – rather than you – earns the income on those assets, or by making a no- or low-interest loan to your spouse, all investment income including interest, dividends and capital gains will be taxed in your hands.
  • Your minor children. If assets are transferred to a minor child, whether through a gift or no- or low-interest loan, you’ll face the tax on any interest or dividends – but not capital gains. Capital gains will generally be taxed in the hands of the minor child. By the way, for the purposes of the attribution rules, a minor child includes a child, grandchild, niece or nephew under the age of 18.
  • Your adult children. A gift of assets to an adult child will generally allow that child to earn investment income that will not be subject to the attribution rules. But there’s an exception here. If the Canada Revenue Agency (CRA) concludes that the loan was made specifically to reduce or avoid tax, all income and capital gains will be attributed back to you. It’s a tough thing for the taxman to prove that your reason for making a loan to your adult child was to avoid or minimize tax, so it’s extremely rare to see CRA apply this rule.

Despite the attribution rules, there are strategies available to split income – one of which I wrote about last week Some income splitting strategies do involve transferring assets to a family member. Be aware that if you transfer assets that have appreciated in value to a family member to split income, you'll be deemed to have sold that asset at fair market value, which could give rise to a taxable capital gain. You've got to count this cost before transferring assets. Next time, I'll share the top income-splitting strategies available.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices.

Alyssa Gowing is a 27-year-old homeowner who follows a strict budget and finds creative ways to save money in order to afford her mortgage

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