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Reduce your Taxes – Income Splitting Strategies

A portion of this article was originally written in June 2009, but relevant today due to the removal of the income splitting Family Tax Cut which allowed a family to notionally transfer up to $50,000 from the higher income spouse to the lower when filing taxes.  While many will take a hit from elimination of this tax benefit (like our family), there are still a number effective income splitting strategies available.

There are a good portion of families that have lop sided incomes between spouses. That is, one spouse makes significantly more income than the other. At a high level, income is income. However, if you look a bit deeper, spouses with lopsided incomes pay higher overall tax than spouses with equal income (assuming both have equal overall income).

For example, for tax year 2016, an Ontario family with a single earner making $100k would pay approximately $22.6k income tax (including spousal credit). Another family with both spouses making $50k each would pay a total of approximately $16.4k income tax.  Both families have the same total income, but one family has an extra $6,200 in annual cash flow.

While many assume that income splitting strategies are for the wealthy, there are income splitting strategies for all income levels.  Some of the strategies below are a bit more advanced than others but take a look to see what can apply to your situation.

Tax Free Savings Account (TFSA)

One of the perks of the new tax free savings account (TFSA) is that the higher income spouse can contribute to the lower income spouses TFSA without any tax implications.  That is, the lower income spouse receiving the TFSA contribution gift can do whatever he/she pleases with the money without having to worry about the timing and taxation when withdrawing from the TFSA (unlike a spousal rrsp, see below).

Separate Accounts

When investing in a non-registered (taxable) account, the taxation of capital gains, dividends and interest are attributed back to the person who funded the account. So in the case of one spouse making significantly more than the other, it’s more than likely that the investment taxes would be taxed in the hands of the spouse receiving the higher income.  At least that’s how CRA would interpret the scenario.  If you’re in this situation, there is a solution to this problem.  Keep separate chequing accounts, and use the higher income spouse to pay all of the household expenses (including income taxes owing for the lower income spouse).  Then use any cash left over from the lower income spouse to invest.  This will help ensure that investment gains and/or income will be taxed at a lower rate.

Loan Money to the Lower Income Spouse

If the higher income spouse has a large lump sum to invest, instead of investing it him/herself, the money can be loaned to the lower income spouse to invest with.  As a result,  the lower income spouse will pay the interest (tax deductible) and the higher income spouse will pay the interest tax on the 1%.  According to Taxtips.ca, the current CRA prescribed rate for a spousal loan is 1% (until at least June 2016).

Spousal RRSP

A spousal RRSP will allow the high income earner to contribute to a spousal RRSP while claiming the tax deduction for him/herself. This strategy also allows for the lower income spouse to withdraw from the spousal RRSP during low income years (providing the timing is right).  The real benefit of this strategy is that it helps even out the incomes during retirement.  This in turn will reduce the overall family taxation.

More details on the spousal RRSP here.

Pension Splitting

This is another retirement income splitting strategy where pensions can be split to reduce family taxation.  Pensions like registered pensions (like defined benefit pensions), Canadian Pension Plan (CPP), Registered Retirement Income Fund (RRIF), and annuities all qualify for pension splitting.  Most tax software packages (or an accountant) will take care of this splitting and optimize your tax return.

Dividend Sprinkling

This a strategy where a family has business income and  owns a private corporation (ccpc).  In this scenario, the ideal situation is where both spouses are shareholders, but of different share classes.  The reason being is that the corporation and choose the share class that will receive the dividend.  Highly paid professionals, like Doctors, use this strategy often, especially if her/his spouse does not make as much income.  In this case, the doctor’s corporation will be setup with dual (or more) share classes which gives the ability for the corporation to distribute dividends to the lower income spouse, thus lowering overall family taxation.  More information on the dividend sprinkling strategy here.

Do you and your family practice any income splitting strategies?  If so, I’d like to hear about them in the comments.

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 28 comments… add one }
  • Derek June 1, 2009, 12:16 pm

    These ideas should help me a lot. I make more than my fiancee and I will be debt free in 2 months. That extra money every month will give me the ability to setup a TFSA or RRSP for her and pay less taxes on my income at the same time.
    I will look into using a few more of the tips as well. They will just take some thinking.

  • Sarlock June 1, 2009, 1:47 pm

    We are fortunate in that because I a run a company, we are afforded some additional income splitting methods. We have set up a trust fund which holds shares of the main income earning company. The income from the company is then paid out as a dividend to the trust and then from there, I can choose to whom the income goes and can evenly split it between my wife and I. As an added bonus, the trust also owns a holding company and any income that is earned in a given year that we do not want to take as personal income and pay tax for is then moved over to the holding company and kept there until such time (such as a year with poor earnings or a requirement for a lump sum withdrawal) that we want to take it back out as a dividend.
    Additionally, once my children (who are also beneficiaries of the trust) reach age 18, they can then take dividend income from the trust as well in any amount I choose (since I am the trustee). This, in effect, creates an RESP for my children that gives me all of the freedom and flexibility in the world that an RESP does not grant. They can receive dividends that will go toward tuition, living expenses, etc, and because they will be earning little to no income during those school years, the taxes on those dividends will be near zero. This means that I do not have to spend a single penny on them with my much higher taxed dollars once they reach 18 years of age.

  • Kathryn June 1, 2009, 4:13 pm

    Wow, Sarlock, that sounds like an ideal situation.

    What a thorough informative article. We are in the situation where my spouse makes about 2/3 of the income and I make 1/3.

    For now we have joint accounts but max out our TFSAs. Before TFSAs he contributed to both his RRSP and a spousal RRSP to keep things more equal in retirement.

    I never knew before today that you had to ‘loan’ your spouse money for them to invest. I thought that while married, you could put it in either name as long as the lower income earner, earned at least as much as the investment. I’m glad I understand it better now as our plan was eventually to live on his salary and invest mine in my name so that I as the lower income earner would pay the taxes.

    Now with the TFSAs it doesn’t matter as much as we don’t have much more than our maximum amount of those combined to invest every year.

  • QCash June 1, 2009, 4:35 pm

    Kathryn

    You have to be careful about “attribution” rules and that is why you need to have these spousal investment loans.

    The attribution rules essentially attribute the income from investments to where the original money came from (or from whom).

    The real object should be to lobby our federal and provincial governments to introduce income splitting for families, not just seniors.

    In Ontario, Tory leadership hopeful, Tim Hudak, has proposed just such a move on the provincial side of things.

  • Jordan June 1, 2009, 9:53 pm

    Sarlock,

    I have a corporation as well, and I think it is the best method of income splitting, unfortunately it’s not an option for most people.

    I wonder why you have nested your income corporation in a trust? You could just have different share classes for each eligible family member and issue a different dividend every year to any amount you want without having a trust. You can also retain earnings in the same income earning corp, unless you are also using it for legal protection?

  • Sarlock June 2, 2009, 1:02 pm

    With family members directly holding shares in the corporation, they have an equity stake in the company and are subject to capital gains if the shares are sold/wound up at a future date. If I sell the company in 5 years, it’s far less complicated to do if the trust just sells the shares rather than have a bunch of individual share holders that have to sell shares and trigger potential capital gains taxes.
    Just the trust owns the corporation and therefore there are no ownership issues. When I pass on, there are no ownership transfer problems (and capital gains taxes)-the company is owned by the trust and the next trustee (which would be my wife) will carry on without missing a beat.
    I can also purchase future companies in this manner as well: Have the trust purchase shares in the new company and then flow income through the trust to any of its beneficiaries (family members and the holding company).
    Many family-owned corporations are held this way for the many advantages it presents.

  • Subversive June 2, 2009, 1:37 pm

    I’d love to hear more from the readers who are self employed, specifically those who have a corporate vehicle in use. I recently became an IT contractor and was required to incorporate. We already had a corporation which owns our rental property, but other than that it wasn’t doing much. Now, my hourly earnings are paid to our corporation and then we write ourselves a cheque for living expenses. My wife is a stay at home mom (and a 50/50 shareholder in the corp, in case that makes a difference), so she has no income. Our accountant says to not worry about it, it will all get dividended out when they do my corporate taxes, but I’d love to hear of any other strategies that self employed people use to keep their taxes as low as possible, or of any ‘gotchas’ that we need to worry about.

  • cannon_fodder June 2, 2009, 7:05 pm

    I think that if the government were to change their policy and implement joint tax returns (as opposed to individual tax returns) they would only end up changing something else to recoup whatever income taxes would be lost.

    Sarlock seems to have some great ways to lessen his families tax burden which probably means he also spends more money in the economy, generating additional benefits.

    We have used spousal RRSP’s almost since we’ve been living together and we will both get into TFSA’s probably next year when we have the money. Even though I make 3x what my wife makes I still have the non-registered account in my name since I’m borrowing to invest. As time goes by, we’ll try to offset that with spousal RRSP’s and TFSA’s for her.

    Neither of us has any pension plans – our employers have only ever offered DCPs throughout our careers.

    An income splitting option that is available only for the very few is for the self-employed. They could employ their spouse/children at a reasonable wage to help out with various administrative tasks and, especially for low income earning family members, the tax paid on that income could be very low or even zero.

  • Sarlock June 3, 2009, 2:39 pm

    Subversive,

    Because your wife is a shareholder of the corporation, she is entitled to dividend income if the Board of Directors (which is likely the two of you) decide to issue one. If you both own the same class of shares 50/50, then that dividend is split evenly. If, however, you each own a different class of shares in the corporation, that allows you to issue dividends to each class of shares in any proportion that you desire.

    Dividends enjoy some benefits tax-wise but do have some disadvantages as well. Dividend income does not create RRSP contribution room nor is it eligible for CPP. That said, CPP doesn’t really pay when you are self-employed anyhow, since you have to pay both sides of the deduction. The deductions are tax deductible, but you still end up putting in around 8+% of your gross income (corporately and personally combined) in to your CPP. For what you will get out of it at retirement, this is a lot of your hard earned money going in to something that will yield a very low rate of return (if not negative).

    Considering that you will likely be contributing to CPP for 30-40+ years before retirement, that is a lot of money saved up for little payoff.

    Take the $2,118.60 max CPP deduction for 2009, double it to $4,237.20 since you pay both sides, multiply that by 40 years and that totals $169,488 (inflation neutral, since deductions will rise around the rate of inflation (if not more than)). At age 65 you can pull your full CPP and begin enjoying your maximum $908.75 per month payments. That is $10,905 per year. So if you live to 81, 16 years of payments will about reduce your original principal to zero. Of course, you’d expect some return over inflation on that $160k investment, so it’s more likely you’ll have to live to 90 or 100 before you even come close to what you could have done with that money if you had invested it yourself 40 years ago.

    The other thing you lose with dividends is your RRSP contribution room. But given the level of government spending right now, I am very fearful that future income tax rates will be substantially higher than they are now and all of those RRSPs will be coming out at as high or higher a tax rate than they originally went in.

    Long and the short of it is, I am choosing dividends over wages as a corporate income distribution strategy.

  • Subversive June 3, 2009, 5:19 pm

    Thanks for the reply Sarlock.

    I already have a large amount of RRSP room accumulated, over $75,000, as I’ve been in the work force a number of years and never really had my financial house in order until just recently. So, I’m not terribly worried about accumulating RRSP room at this point. If I ever go back to being a salaried employee, then RRSP contributions will become a focus again and I’ll be growing my RRSP limits anyway, so it will make sense.

    We’re planning to try and max out the TFSA. We’ve also signed up for PHSP (private health services plan) via the corporation, which will allow the corp to pay any medical/dental/vision expenses for the family and write off the expense. Since I don’t have benefits anymore, we felt this was important.

    The tax avoidance is the main thing I’m looking for. As long as dividends are the best for that, then that’s great.

  • Jordan June 3, 2009, 5:31 pm

    Subversive,

    I have one a PHSP as well and it has been extremely beneficial because I’ve had high therapy costs for my son. But you need to make sure it actually makes sense because some PHSP’s will charge you a set percent of the claims, like 5%. This service charge could easily eat away the savings you would get because most PHSP eligible expenses would otherwise be a personal medical expense tax write offs anyways.

    The PHSP I use has a straight $50 per year, per claim processing fee, if it had been 5% it would have cost $500 last year!

  • Jordan June 3, 2009, 5:34 pm

    Sarlock,

    What is the administrative overhead of having your corporation inside a trust as opposed to being owned directly? Does a trust have to keep a separate set of books and file an annual T2?

    Was I correct that you have a separate holding company for liability protection, or is there some other reason you don’t retain earnings in the income corp?

    My concern with the advantage of nesting corporations and trusts is just that the costs grow and will outweigh the benefits. Filing a T2 for a single corp costs me ~$700/year, so I assume having a holding company and trust it would be close to $3000/year.

  • Subversive June 3, 2009, 5:42 pm

    Jordan, which PHSP do you use? I did a bunch of research on the net and the best I could find was one which charged a one time $100 fee and then 5% of any submitted expenses. I found others than charged as high as 15%, so I thought the 5% fee was pretty good. The good news is if I never use it, there’s no cost except the one time setup fee.

    I understand some costs are a medical write off (for example, we used a mid wife for our first two children, and until this year, it wasn’t covered by Alberta Health Care. it is now), but are things like prescription costs a write off? Also, I plan to get laser eye surgery in the near future. This one should be an excellent candidate for the PHSP, right?

  • Jordan June 3, 2009, 8:14 pm

    Subversive,

    I found the same thing when I was searching online, they all want a % of the claims, but 15% that’s insane!

    I was referred to the service called Promedent Plan (www.promedent.ca), it’s a tiny PHSP that is basically a self serve website. It’s low key, run by an accountant company I don’t think they offer any personal service which is probably why it’s so much more affordable. Like they don’t have a call center to ask questions if something is admissable or not.

    Once a year you basically just submit your claim as an “employee”, then login as an “employer” to accept your claim. It transfers the money from your business bank account and deposit’s it into your personal account.

    Also check out their savings calculator to see how much a PHSP might save you:
    https://www.promedent.ca/calc.asp

    I’m not a PHSP expert, but I think a mid wife would be a normal medical expense, same as prescription drugs, dental work or hospital stays. However glasses, contacts don’t and I think laser eye doesn’t either, so in that case a PHSP could be well worth it.

    Here is a CRA guide on eligible medical expenses:
    http://www.cra-arc.gc.ca/E/pub/tp/it519r2-consolid/it519r2-consolid-e.pdf

  • Sarlock June 4, 2009, 1:05 pm

    Jordan,

    You are correct. An additional set of books and tax filing is required for the trust as well as for the holding company. The income company has to be large enough to generate enough tax savings and defferal options to warrant the additional expense and time that it takes to administer it. I maintain most of the accounting myself and our accountant just does the final tax filing for us, but it still costs around $1,500/year.

    There are a couple of reasons I do not retain excess income in the main corporation. The first and most important is capital/liability protection. If something does occur (nothing that I am anticipating, but stuff happens) and the main corporation has to file for bankruptcy or gets hit with a massive lawsuit above our liability insurance limits, the additional retained earnings are protected in the holding company and are still available for personal income purposes. With the exra cash that sits in the holding company, I can then invest it in to an array of income-generating options, including other companies, stocks, bonds, whatever.

    When the main corporation has a good year and issues a large dividend, we only have to take (and pay tax on) what we need personally and leave the rest in the holding company to with as it wishes. Then if we have a poor year, we can draw a little extra from the holding company to even out the bumps and reduce our overall tax burden (the tax rate on high income is brutal). Having two years pulling $50k/year each instead of $100k in the first year and $0k in the next will produce a better overall tax rate.

    The holding company is also where I am building up funds for my children and when they turn 18, they can receive a “management fee” from the holding company which can go towards tuition, living expenses, etc. As they will be earning little to no other income, most of this money will flow to them tax free. The idea is that I will not give them a single penny personally: Whatever they need (as long as I approve the expense, of course!) will come as a dividend from the holding company, through the trust and in to their hands as low (or no) tax dollars.

    Another advantage: Because the trust owns the shares of the income generating corporation, when the day arises that I decide to sell the company and record the capital gain on the shares, because the trust owns it, the trust receives the capital gain. I can then split this capital gain between myself and my children and *each* person can claim up to the $750,000 small business capital gains exemption. That means our family could potentially make a $3,000,000 capital gain on the sale of the company and not have to pay a single penny in tax. Compare that to if I held the shares myself and had to pay capital gains tax on $2,250,000!

    • ToddF July 14, 2016, 5:15 pm

      Hi Sarlock,

      I’m intrigued! This is an interesting way to structure things and I’ve just recently been reading up on trusts in Canada.

      I’m assuming your trust makes no money in any given year and thus pays no tax, because any dividends would flow through to the beneficiaries (you and your wife) and taxed in your hands or transferred to the holding company for investment.

      I’m wondering if you have any comments for your situation on the 21-year rule, which says the trust needs to dispose of all it’s assets after 21 years. Is your plan to sell your company and payout all the assets before then?

      I’m also wondering if this is a good way to go for rental properties. Basically setup a company to own and run the rentals and then either move income to holding company or distribute to beneficiaries.

      Last question, For the holding company and income earned (interest, dividends, or capital gains) it would need to pay tax correct? Is that at the business tax rate of 16%?

      Thanks for the great comments,
      -Todd

  • Ms Save Money June 4, 2009, 4:48 pm

    The separate accounts really helps. I’m the saver in the relationship and my significant spends everything. If I didn’t save for us – we definitely wouldn’t have any money at all.

  • Youngmoney June 13, 2009, 12:18 pm

    Hi Everyone,
    My spouse and I are 30 years old, I make $160k a year and my spouse is a full time student with no income. We are planning to have children shortly and will continue to be in the same situation for at least the next 3 years where I bring in the income for the family.
    I would like to understand what other options are available to split the income for the purpose of reducing the taxes we pay every year?
    Can you share feedback on if you think it would be beneficial for me to approproach my employer to pay me as holding company (which I could split with my spouse)? Is this a worthwhile exercise based on the income I make?
    What are some of the considerations I would need to consider by not being a full time employee? Would I need to be insured/WSIP/Medical benefits/Disability?

    I will paying over $50k in taxes again this year and want to see what other options we have available.

  • JB October 7, 2011, 12:19 am

    I make over $100,000 and my husband does not work at all. What can I do regrding income splitting, if we are not retirement age?

    Can you provide me with a thorough explanation and recommendation please.

    What options are avaialble to me? Ontario/Canada

  • Robert September 4, 2012, 4:38 pm

    “Keep separate chequing accounts” – What about 2 joint checking accounts with different banks? Each spouse gets paid in one of the 2 accounts (keeping them joint for practicality) so it is fairly easy to track everything.

    Will that work with two joint accounts at the same institution (1 checking and 1 savings)

    Appreciate your opinion

  • Aram April 25, 2016, 6:25 pm

    Here is my strategy:

    1. Both me and my wife are employed by my corporation, so split the income by simply paying us equaly salaries. Moreover, I keep those salaries low, so that they don’t hit higher tax bracket.
    2. The remaining income stays in corporation and is taxed at 16%. I then borrow those funds and I avoid personal income tax in 40% bracket. Eventually I will have to pay them back, but till then I can save on taxes and have more money for investing.
    3. When we max out our TFSAs, we can start RRSP and claim tax credit without having paid those taxes in that year, due to huge accumulated contribution room.
    4. I also may choose to return the debt and pay those funds as salary in a year of lower income.

    • FrugalTrader FrugalTrader April 26, 2016, 4:36 pm

      Aram, what interest rate do you have to pay to borrow from your corporation? How long can you borrow the funds for?

      • Aram April 26, 2016, 5:43 pm

        I can borrow for as long as my corporation allows me to borrow (i.e. indefinitely :) ).

        As of interest rate, my accountant has suggested 1% rate. I haven’t paid the interest before, since this is first year I am borrowing from my corp. (going to pay it at the end of fiscal year in July). My understanding is that the rate cannot be less than Central Bank’s overnight rate (currently 0.5%) or the “Bank Rate” (currently 0.75%).

      • Aram June 27, 2016, 4:08 pm

        An update:

        As my fiscal year ended recently, I had to take care about taxes related to borrowing funds from corporation. Here is what I have learnt from my accountant.

        CRA defines a set of “prescribed rates” (see http://www.cra-arc.gc.ca/interestrates/). The one that was of my interest is described in Income Tax paragraph as follows:

        “The interest rate used to calculate taxable benefits for employees and shareholders from interest free and low-interest loans will be 1%.”

        What does it mean? When I borrow from corporation for lower that this prescribed rate (including interest-free loan), the saved interest becomes taxable benefit and should be reported in my individual tax return. E.g. if $100K is borrowed for 0.7%, then remaining 0.3% ($300) become my taxable benefit and are taxed at whatever tax bracket they fall into. 0.7% interest paid to corporation becomes corporate income and is taxed as such.

        If the money are borrowed at 1% or higher, then no taxable benefit is produced for me. Since corporate tax rate is lower than my individual rate, it makes more sense to go with 1+% and pay taxes at corporate rate.

  • J April 26, 2016, 10:12 pm

    At what income level for the higher earner or what total family income does it really make sense to have an account or tax specialist look at your situation if you are both employees?

    It would seem they would need to find a significant way to reduce your taxes to make it worth it. I make 3x my wife but we have always done our own taxes, etc.

    • FrugalTrader FrugalTrader June 17, 2016, 10:36 pm

      J, I would say keep using online software until your tax situation becomes too complicated to do it yourself.

  • BC Game Developer June 6, 2016, 12:43 pm

    I have a question related to selling your primary residence? Living in Vancouver housing prices are out of control and we are thinking of cashing in. Our house is in both my wife and my name, although I am the only income earner in the family and have paid for the mortgage over the years. Does this mean that the profits of the house sale are attributed to me or can it be split between my spouse and I.

  • FrugalTrader FrugalTrader June 6, 2016, 1:43 pm

    Gains from your primary residence are not taxable. I’m betting this is the best news you’ve heard all day? :)

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