Last week we discussed the advantages of income splitting with a family members in a lower marginal tax bracket to reduce tax and the attribution rules under the Income Tax Act that need to be considered. Here now are a few of the strategies that can be employed without triggering those attribution rules:

Contribute to spousal RRSP

An easy way to split income is to have the higher-income spouse contribute to a spousal RRSP. The contributing spouse will get the tax deduction for the year the contribution was made (assuming the individual has sufficient contribution room), while the lower-income spouse will be taxed on the withdrawals made during retirement at their lower tax rate. The goal with spousal RRSP is for each of the spouses to have equal income at retirement. Therefore you should consider the tax rates for each spouse at retirement before employing this strategy. Note any withdrawals from a spousal RRSP within the three years prior to the last contribution will be subject to attribution rules and be taxed back in the hands of the contributing spouse.

Invest in a minor child’s name:

As mentioned previously capital gains earned in the hands of a minor child are not subject to the attribution rules. Therefore it is possible to split income with a minor child by gifting assets that will earn primarily capital gains. Any interest or dividends earned on assets transferred to a minor child will be attributed back to you.

You don’t have to be concerned about the attribution rules if you invest the Child Tax Benefit you receive in respect to that child. Any investment returns can be taxed in the hands of the child. It is usually a good idea to keep these assets in a separate account from any other investments that come from you.

Split your CPP benefits:

If you are over the age of 60 and receiving benefits from the Canada Pension Plan (CPP) you can split your benefit with your spouse or common-law partner. You can have up to 50 per cent of your benefit reported in your spouse’s (or partner’s) hands. Assuming your spouse is in a lower marginal tax bracket you will save tax on an overall family basis.

For example Ted is receiving a benefit of $700/month from CPP and gets approval by Social Development Canada to split his benefits with his spouse Alice, who has minimal other income. Both Ted & Alice will receive $350 per month but while Ted, who is in a 40% tax bracket, will pay $1,680 on the $350 month he receives, Alice will not attract any tax on the $350 she receives, a tax saving of $1,680 per year overall.

Contributing to an RESP for your child’s education:

Registered education savings plans (RESPs) are great way to save for your child’s education and provide income splitting benefits at the same time. Like an RRSP all growth within the plan grows on a tax-deferred basis and only when it is withdrawn that the growth (not the original contributions) becomes taxable. As long as the funds withdrawn are used when the child is attending a post-secondary educational institution they are taxed in the child’s hands not the original contributor’s. And a student with minimal income and eligible for education tax credits is likely to pay little or no tax on withdrawals from the RESP.

Another advantage of RESP’s that they will attract grants both federally (Canada Education Savings Grant) and provincially in Alberta (Alberta Centennial Education Savings Grant) which make them a very attractive planning tool for education savings. The rules can be complicated and proper advice should be obtained in order to receive the maximum benefit.

Pay family member a salary:

If you own a business, you can hire family members so long as you pay them a reasonable wage for the work performed. The business is entitled to a tax deduction for the wages paid, while the family members are taxed on the income earned. By putting more income in the hands of lower income family members you will manage to save tax on an overall family basis. Further your family members will have a source of funds for investment purposes and the attribution rules don’t apply on investment returns on those funds. Also family members receiving salary or wages will generate RRSP contribution room to be used to save for retirement.

At PlanWright, we are happy to work with you on these and other financial questions you may have. Call 842-1370 to book your appointment.

April 23, 2008