News from The Globe and Mail


Wednesday, April 02, 2003

Splitting income is a family affair. And while the government eliminated some high-profile means, "there are still a number of very effective ways to minimize taxes among various family members," says Robert Snowdon, an Ottawa-based chartered accountant.

Income splitting is simply moving income from the hands of one family member to another who will pay tax at a lower rate. One of the most effective ways to do that is through a family trust.

While Ottawa eliminated certain income-splitting opportunities for children under 18 in 2000, family trusts associated with a small business corporation (SBC) offer opportunities for families with kids 18 and older.

Mr. Snowdon provides an example of an Ontario family with two adult children attending an out-of-town university at an annual cost of $20,000 each. An operating company would pay dividends worth $40,000 to the trust, which would, in turn, distribute that money to the students.

The resulting annual tax savings, taking into account the difference between Ontario's SBC tax rate of 19.12 per cent and the top personal marginal tax rate of 46.41 per cent, would be $10,916.

"Furthermore, by having the operating company shell out the dividends, mom and dad wouldn't have to dip into their after-tax dollars to pay that out," he says.

A family business can also be an excellent source of income-splitting so long as members are paid a reasonable wage for work performed and all of the particular details -- hours worked, type of work performed and the company's payroll -- are meticulously documented, says Larry Hemeryck, a certified general accountant at Millard Rouse & Rosebrugh in Simcoe, Ont.

Another technique when one spouse earns more than the other is to have the higher-income partner pay the daily living expenses. This would help the lower-income spouse save his or her money for investing purposes, subjecting the family unit's investment income to a lower marginal taxation rate.

"That's an obvious and basic but often overlooked income-splitting technique," says Cheryl Mont, a Toronto-based certified general accountant. "But the important thing for the taxpayer to remember is to be very careful about keeping a paper trail to prove this strategy is being followed."

Another often-overlooked opportunity is for couples to split their Canada Pension Plan benefits, using a formula that takes into account how long they've been married while earning them.

This would most benefit couples married for a long time. If they wed at about age 25, near the beginning of their careers, they would likely be able to split close to all of their benefits; if they married around 40 or 45, the CPP benefits based on their first 20-odd years of earnings wouldn't count and only about half would be eligible for income-splitting, explains Mr. Hemeryck.

This strategy could also have a significant tax impact on the family unit if one spouse's income is appreciably higher than the other's. "Especially if that high-income earner is close to $57,000, where the old age security clawback starts to kick in, shifting that money to a taxpayer in a lower bracket definitely helps," he adds.

Parents can income split with children by ensuring the monthly Canada Child Tax Benefit cheque is deposited directly into the child's account. This way, the amount becomes taxable in the name of the child, who likely won't have to pay anything. If tax authorities ask, parents must be able to prove the funds went into the designated account.

Another option is to make a loan to a spouse with interest charged at the lesser of commercial rates or the prescribed rate determined by the Canada Customs and Revenue Agency. So long as the spouse pays that rate to the transferor on an annual basis within 30 days after the calendar year end, the income earned would be taxed in their hands.

Spousal registered retirement savings plans and registered education savings plans also present good long-term income-splitting opportunities.

While taxpayers must terminate their own RRSP at the end of the calendar year in which they turn 69, contributions to a spousal RRSP for a younger spouse can still be made until the end of the year in which the spouse turns 69.

The spousal RRSP can also result in long-term savings if the balance in each plan is equalized, providing taxpayers and their spouses with the opportunity to equalize retirement income and reduce their future tax liability.

It may also be beneficial in instances where one spouse belongs to a registered pension plan and the other doesn't. In that case, it is worth building the non-pensioned spouse's RRSP to make their income more equal at retirement.

A word of caution, however: if spousal contributions are withdrawn from an RRSP by the person receiving the funds either later that same year or during the next two years, those funds will be attributed back to the contributor (unless, of course, the spouse was forced to withdraw funds after converting the RRSP to a RRIF).

The annual contribution limit for RESPs is $4,000 per beneficiary, with total lifetime contributions up to a maximum of $42,000. The federal government will also contribute up to $400 annually.

Although the contributor cannot deduct the principal amount, over a period of time -- up to 25 years -- the RESP can accumulate significant interest.

"When a parent or grandparent makes a contribution to an RESP, the income earned on that money is going to be taxed in the hands of the student when they withdraw the money," Ms. Mont says. "Consequently, there may be a very long period of time when that money is sitting there earning tax-free income, which will ultimately be taxed at a presumably very low tax rate."

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