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What is income splitting and what are the benefits?

Income splitting is the loaning or transferring of money to a lower-income person (for example, a spouse, common-law partner or child) so that the income or gains from investing the money are taxed at a lower tax rate, which decreases the overall tax burden of the family unit. Income attribution rules generally block attempts to shift income to another person by attributing it back to the first person. While these rules eliminate most opportunities for income splitting, there are still a few left for income splitting within a family. Some income splitting opportunities that are available are:

Capital gains and children
Attribution does not apply to capital gains earned on disposition of property by a child. So it could be advantageous to loan or transfer funds to a child to invest in assets that tend to generate more capital gains than income over time. This will reduce the income attribution to the lender or transferor and ensure that the gains earned are taxed in the child’s hands.

Child tax benefit
Like the old family allowance payments, the child tax benefits received by some families may be invested in the child’s name without any attribution of income back to the parents. Parents no longer receiving child tax benefits lose the advantage of having this source of funds available to invest for their children.

Canada Pension Plan benefits
Spouses or common-law partners who are each receiving their CPP benefits can get a portion of each other’s pension, if they choose. Since each spouse or common-law partner pays income tax only on the amount he or she actually receives, this can be an effective income-splitting technique.

Income on income (secondary income)
The attribution rules apply to income from property that is transferred or loaned. If this income is reinvested by the transferee or borrower, it will earn a secondary stream of income. This “secondary income” is not attributed back to the transferor or lender because it is not income from the transferred property. It will be taxed in the transferee’s or borrower’s hands. It can therefore be advantageous to loan or transfer property to a spouse or common-law partner or minor and allow the income attribution to occur on the income from the original investment. Then that income can be removed from the account and invested elsewhere, where it continues to earn a secondary stream of income on which no attribution occurs. This secondary income is taxed in the hands of a lower-income family member.

Loan or transfer made to earn business income
If a loan or transfer is made to earn business income (as opposed to income from property such as interest, dividends, rent or royalties), attribution will not apply.

Payment of expenses and taxes for lower-income family members
One of the easiest ways to split some income is for the high-income earner to pay all of the family’s daily living expenses. This leaves more income in the hands of the lower-income earners to invest, thereby increasing their investment income, which will be taxed at lower rates. Payments of taxes on behalf of other family members also fall into this category. These payments will not attract attribution since they are not invested (the payment goes to the government), and therefore there is no income that can be attributed back.

Registered Education Savings Plans (RESPs)
Contributions of up to $4,000 per year (to a maximum of $42,000 over 21 years) may be made to an RESP to save for someone’s post-secondary education. And, if certain conditions are met, the beneficiary may qualify to receive the Canada Education Savings Grant (CESG), which is equal to 20 per cent of the RESP contributions to a maximum of $400 per year. The contributions are not tax-deductible, but the contributor can withdraw these contributions at any time tax-free.

Salary to spouse or common-law partner or children
If a person carries on a business, either personally or through a corporation, some income splitting can be achieved by paying a salary to a spouse or common-law partner and/or children. You must ensure, however, that services are genuinely being provided and that the amounts paid in salary are reasonable in relation to these services.

Spousal Registered Retirement Savings Plans (Spousal RRSPs)
Contributions made to a spousal RRSP are deductible by the contributing spouse or common-law partner within the applicable contribution limits.

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