Income splitting is a family tax planning technique designed to shift income from a higher-income earner to a lower-income earner to reduce the overall tax paid by the family.
An example of income splitting
The following simple example will help you understand the basic idea.
Jim and Marry are married and live in Toronto. Jim is earning $150,000 from his business operating in his basement. Marry is making $30,000 working in a day care center. Based on the tax rates of 2009, about $58,000 will go to the taxman. If Jim can somehow shift some of his income to Marry, for example, paying a salary of $30,000 to Marry for her help in his business. The overall tax bills for the family will be reduced to about $54,000. The couple saves about $4,000 in taxes.
Progressive income tax system
Why can Jim and Mary save taxes by shifting their income? It is due to the progressive income tax system. In Canada, different tax rates (marginal rates) are applied to different levels (brackets) of income. The portion of income in the higher level (bracket) is taxed in a higher rate. By shifting income from Jim to Marry, we manage to move income that will be taxed in higher rate into the bracket with lower rate. That is why the tax is saved.
Income splitting techniques
Although some income splitting techniques require complicated planning, some are quite easy to understand and implement. For example, hire your spouse or child in your business and pay them salary or consulting fees; transfer property to your child and capital gain will be taxed on the hands of your child; hire your adult child to baby-sit your child under 16; loan money to your spouse to invest and charge interest at prescribed rate; invest money received from CCTB in the name of your child and income earned will be taxed on the hands of your child; contribute to spousal RRSP or RESP to earn tax deferred income taxed on the hands of your spouse or child.
Attribution Rules
However, you need to know the so called “Attribution Rules” in our tax law designed to prevent you from shifting income between family members. If you are caught by these rules, any income you have shifted to a family member will be attributed back to you and taxed in your hands instead. You must be careful to follow the rules, so as to avoid the wrath of the taxmen.
