Strategies to Reduce Taxes – Family Income Splitting
Strategies to Reduce Taxes – Family Income Splitting
The Canadian income tax system is considered “progressive”. In other words the more money you earn the more tax you are expected to pay. Individuals are encouraged to explore all legal strategies to reduce their payable tax. Family income splitting has been a vehicle for individuals to reduce their tax obligation.
There are however a few rules that hinder family income splitting.
Rule #1- No joint tax return filing
In Canada there is no so-called joint tax return, where a husband and wife file a single tax return. Each individual must file their own tax return based on his or her own income.
Rule # 2 – The “Kiddie Tax”
Certain specified incomes such as some trust and dividend incomes are now taxed at the highest possible tax rate.
Rule # 3 – Income Transfer Between Spouses
Money cannot be transferred between spouses in an attempt to reduce the tax obligation of the higher income earner.
Rule # 4 – Income Transfer between parents and minor children
Money cannot be transferred between parents to their minor children in an attempt to reduce the tax obligation of the parents.
So if all of these rules are in place, then what can a person do to legally reduce their tax obligation?
Please note that all of the following options are to be done very carefully only after reviewing your specific situation with your professional accountant such as Numbers plus, as errors in any of these strategies could have significant negative consequence.
There still remain strategies to split family income that can assist you in reducing your tax obligation. These strategies may or may not apply to your individual financial plans or goals. At Numbers Plus we can review your situation and create an effective family income splitting strategy to put more money in your pocket.
Family Income Splitting Strategies
Strategy # 1 – Tax Free Savings Account (TFSAs)
TFSAs allow individuals older than 18 years old receive 5,000.00 of TFSA contribution each calendar year. There is no tax deduction received on this money but the money is not taxable when it is withdrawn.
Strategy # 2 – Loans to a Spouse or Children
Loans can be made to spouses or children as long as the spouse making the loan charges an acceptable interest rate to the spouse or child receiving the loan.
The child or spouse receiving the loan must own an investments portfolio and pay tax on the dividends paid. They must also show proof that they have paid the acceptable interest rate to the spouse loaning the money.
Strategy # 3 – Investment of funds by a lower-income spouse
Loans can be made from a higher income spouse to a lower income spouse provided the lower income spouse uses the loan for investments. The lower income spouse will be taxed at applicable rates but a permanent tax savings can be achieved.
Strategy # 4- Employment of a Spouse or Children
If you own a small business or are self employed then this strategy can help you keep the money in the family. You have the opportunity to employ family members that can do the work. You must pay your family member at a rate that you would pay a non-related individual and you must follow all of the usual obligations as an employer.
Strategy # 5 – Pension Income Splitting
This is an effective way to minimize tax but can only be used on private pension plans or personal RRSPs. Government sponsored plans such as CPP or OAS cannot be split amongst spouses.
Strategy # 6 – Credit Transfers
There are a number of non-refundable tax credits at both levels of government that are available to each individual filing a tax return. In a family, if one spouse has already used a number of credits to reduce their tax payable liability then the other spouse can use any remaining credits to reduce their income. In addition expenses can be grouped together, such as charitable donations and medical expenses and claimed by one spouse or split accordingly. Children can transfer their school tuition and education expenses to one of their parents.
The strategies outlined above give a family legitimate ways to reduce their overall tax liability. As mentioned these strategies can be maximized according to your personal financial goals. Call us at numbers plus today and we can give you an assessment on how to deploy these strategies and put more money in your pocket.
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