Income Splitting - 2022
TIME SENSITIVE - Take advantage of an income splitting strategy with your family members before July 1, 2022
While many countries allow families to file consolidated returns, in Canada, unfortunately we are not able to do so. Therefore income-splitting strategies are an effective and important approach to minimizing overall income taxes for the family. While our government in recent years has implemented changes that limit strategies available, one relatively simple and effective approach is to lend money to your lower-earning spouse, or a child over the age of 18. With a properly documented intra-family loan agreement, any investment income generated using the loaned funds will be taxed at their lower tax rate, not yours. While this strategy can also be used in more complicated strategies with the use of trusts, for the purposes of this blog post, we are focusing on the simple and less expensive approach.
Why a loan?
Income generated on funds that are gifted to a spouse will attribute back to the giver and will be subject to their higher tax rate. However, a loan can help avoid income attribution so that income generated on the loaned funds will be taxed at the loan recipient’s lower tax rate.
Why is it Important to Act NOW?
To avoid income attribution, the loan to your spouse must include an interest rate equal to the CRA prescribed rate. From July 1, 2020, to June 30, 2022, the rate is 1%. As of July 2, 2022, the prescribed interest rate increases to 2% so now is the time to act if you are considering income splitting. Any loans created on or before June 30, 2022, will be able to use the 1% interest rate for the duration of the loan.
What is the benefit?
Any earnings in excess of the 1% prescribed interest rate are taxed in the hands of the lower income spouse or family member. With our graduated tax rates in Canada this can result in a maximum savings of about $39.5K per person (Essentially the benefit is the difference between the highest marginal rate of 53.53% and the existing marginal tax rate of the lower income spouse or child). The benefit is eliminated when a spouse or family member reaches income of about $222K in taxable income as that is the level (in Ontario) when the highest marginal rates apply.
Is Income Splitting worth it?
Absolutely! Income splitting allows the family to significantly lower the effective rate of tax payable on investment income. By moving the funds for investment to the lower earning spouse by way of a loan, the tax payable on the income generated by the investment decreases significantly. If there is sufficient difference in earnings between the spouses, income splitting will reduce the tax payable on the investment income by about half.
Questions?
It is important to consider tax strategies in light of your overall situation. We wanted to provide you with this update given the time sensitivity but caution it is important to consider all of the strategies available based on your family situation (considering other more complicated options). If you are interested in income splitting and have questions, please reach out to your advisor at digitaltaxCPA. We’d be more than happy to discuss your situation and see what works best for you and your family.
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