July 2004

Married Individuals - Income Splitting & Tax Savings

Married couples (including commonlaw partners) can generally save thousands of dollars in taxes over their lifetimes by ensuring that their incomes are split as evenly as possible amongst each spouse. The savings are as a result of the lower tax rates available at lower levels of income. One or more of the following ideas may help reduce your tax bill.

Loans to spouse
The higher income spouse makes a loan to the lower income spouse at the prescribed rate of interest (July through September 2004, 2%). Provided the lower income spouse can generate a return greater than 2%, the overall tax burden of the couple will fall. The spouses should document the amount advanced and the interest rate by way of a long-term promissory note. It is essential that the interest be paid no later than 30 days after the end of the year.

Use of funds
The higher income spouse could use all of their income to pay for household and personal living expenses while the lower income spouse uses all of their income (maintained in a separate bank account) for investment and savings purposes. The married couple would achieve a greater aftertax return on their investments.

Retirement assets
The higher income spouse could make contributions to a spousal RSP for the benefit of the lower income spouse. The overall taxes paid during retirement would be lower if retirement incomes are comparable. This could also potentially prevent the claw-back of government benefits. A couple could also ask the government to split their CPP entitlements

Shifting losses
This planning idea is best explained by way of an example. Mr. A, who has never realized a capital gain or loss in the past, owns 100 shares of Nortel with an accrued loss, whereas Mrs. A has realized capital gains in the year. Mr. A would sell 100 Nortel shares and Mrs. A would acquire 100 Nortel shares within 30 days thereafter. Provided Mrs. A owns her 100 Nortel shares on the 30th day after the original disposition, then the capital loss of Mr. A is added to the cost base of her Nortel shares. By then disposing of her Nortel shares, Mrs. A would be able to recognize a loss and offset her other gains. The accrued capital losses in the above example could also be transferred directly to one spouse by way of a sale at fair market value. By ensuring that fair value consideration is given, the income attribution rules will not apply.

Private business owners
If one spouse operates a profitable business it may be desirable to split the income of the business between the spouses. This could be accomplished by introducing the other spouse as a shareholder or paying them a reasonable fee for services rendered. Having a spouse as a shareholder would also multiply access to the $500,000 capital gains deduction on the sale of a business.

Testamentary spousal trusts
Where one or both spouses have accumulated significant assets they may want to establish a testamentary spousal trust in their wills. The income of the trust would be available to the surviving spouse during his/her lifetime. Income earned will be subject to a lower rate of tax in the trust than if combined with the spouse’s existing income. The settlor of the trust would decide in his/her will how the balance of the assets of the spousal trust are to be distributed on the death of the surviving spouse.

It is important to remember that there are non-tax implications to the above planning ideas that should be carefully considered.

Chris Bodnar, C.A.
Tax Partner, Crawford, Smith & Swallow, LLP

Readers are urged to consult their professional advisors prior to acting on the basis of material in this newsletter. If you have any questions regarding the content of this newsletter, please contact Crawford, Smith & Swallow. Copies of the newsletter in PDF format are available on our website.