Your family’s overall income tax bill can be reduced through the effective use of income splitting strategies such as the Spousal Loan Strategy, a prescribed rate loan to an RBC Family Trust, Spousal RRSPs and pension income splitting.
There are two reasons why income splitting is so important to reduce your family’s tax burden:
> Canada’s tax system is based on graduated tax rates
> Everyone in Canada has a tax-free basic exemption amount
A graduated tax rate system basically means that there is a higher marginal tax rate on taxable income as income increases. Furthermore, each Canadian resident can earn about $9,000 (varies by province) of taxable income every year tax-free due to the basic personal tax credit. As a result of these two factors, if income can be shifted from a high income parent to a low-income spouse or child, then the family can realize tax savings of up to $15,000 per year (varies by province). If there are four members in a family, then family tax savings of up to $45,000 per year can be realized. When you consider the amount of potential annual tax savings, it makes sense for families earning a high income to strongly consider family income splitting strategies.
In order to prevent abusive income splitting arrangements, the Income Tax Act has income attribution rules. These rules will attribute taxable income back to the high-income family member that actually supplied the capital for investment, thus achieving no tax savings. The abovementioned income-splitting strategies are permitted by the Income Tax Act as valid strategies. Business owners can split income by paying reasonable salaries to lower income family members based on the services they perform. However, if a low income spouse or child is not actually working in the family business or their services are minimal, then paying them a salary or bonus that is in excess of the services rendered simply for income splitting purposes is not permitted.
If you own a Canadian corporation, there are a number of creative strategies to split income with family members. One such strategy, typically done in combination with an estate freeze, is called “dividend sprinkling.” Although there are some attribution rules to consider, this strategy involves paying dividends from the corporation to adult children and spouse shareholders based on the growth of the corporation after the estate freeze. If the spouse or adult children had no other income, then approximately $10,000 – $50,000 of tax-free dividends (varies based on your province and eligible dividend tax rules) could be paid to them from the corporation every year if structured properly.