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When Carolyn and I got married 27 years ago she jokingly said: “What’s mine is mine, and what’s yours is mine.” When our son recently got married, I told him that putting assets in his wife’s name can actually save them tax dollars. But it has to be done properly. It’s what is known as income splitting.
The concept
Income splitting is the idea of shifting income from the hands of one family member to another, who will pay tax at a lower rate. The challenge? If you simply give your spouse assets that generate income, the attribution rules in our tax law will generally cause any income earned on those assets to be taxed in your hands. The good news? There are ways to side-step these rules to split income. Consider these ideas:
Transfer money for a business. If you give or lend your spouse money to earn income from a business, the income won’t be attributed back to you. Only “income from property” (most commonly interest, dividends, rents, and royalties) and capital gains will be attributed back to you.
Make a spousal loan. It’s possible to lend money to your spouse, charge the prescribed rate of interest, and have your spouse earn income on the money with no attribution back to you. Your spouse will have to pay the interest every year by Jan. 30 for the prior year’s interest charge, and you’ll have to pay tax on that interest. Your spouse can claim a deduction for the interest. As long as your spouse earns more income than is paid to you, you’ll save tax as a couple. This idea was easier when the prescribed rate was very low in the past, but will be in vogue again as interest rates fall. The prescribed rate is set quarterly, and is falling to 5 per cent as of July 1, 2024.
Lend for second-generation income. If you don’t want to charge interest on the loan to your spouse, try lending the money for a period of time – say five or 10 years – and charge no interest. The attribution rules will apply to the original loan amount every year, but you can take the income earned each year and move it to a separate account for it to grow. This is called second-generation income, and is not subject to the attribution rules. After five or 10 years your spouse can pay back the original loan and the attribution rules will cease to apply. The second-generation income will remain in your spouse’s hands to continue growing.
Give capital dividends to your spouse. If you own a corporation that has a capital dividend account (CDA) balance, you can pay that amount to yourself as tax-free capital dividends. It’s possible to make your spouse a shareholder in the corporation too by giving your spouse some shares (transfers of assets between spouses generally takes place at the cost amount, so no tax is triggered). You can then pay your spouse capital dividends. There won’t be any attribution of taxable income back to you since the capital dividends are tax-free. Your spouse can then reinvest those dollars and avoid attribution back to you of income earned in the future.
Tim Cestnick: Getting married? Make sure you understand the tax and financial implications
Pay the household expenses. If you’re the higher income earner, consider paying most or all of the household expenses. This will free-up your spouse’s income for investment purposes. The attribution rules won’t apply to income earned by your spouse on his or her own money.
Swap assets with your spouse. It’s possible to transfer income-producing assets to your lower-income spouse. The attribution rules won’t apply if your spouse pays you fair market value for those assets. In exchange for receiving income-producing assets, the lower-income spouse could, for example, transfer to the higher-income spouse his or her share of the family home, or other non-income-producing assets of value such as jewellery, artwork, or a collection of some kind. Keep in mind that electing to transfer certain assets to your spouse at fair market value could give rise to taxable capital gains, so count this cost first.
Pay your spouse a salary. If you own a business, you can pay your spouse for work he or she performs in that business. It’s a deduction to the business and taxable to your spouse. If you’re the higher-income earner, and you want to start a business, consider creating a proprietorship and paying your spouse a reasonable amount to operate the business. If you lose money in the first year or two (which is common) those losses will offset your other income. Once the business is profitable, you can transfer the business to your spouse without tax and he or she will report the profits as income going forward.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at tim@ourfamilyoffice.ca.
