Income splitting: a new opportunity

… but you have to act fast!

Never before seen: The Canada Revenue Agency recently announced that the prescribed interest rate for the second quarter of 2009 is barely 1%.

Is all this Greek to you? It isn’t for couples who want to split their income to lower their taxes. In fact, they should be talking to their tax advisor about this right now so that, hopefully, they can set up a rational strategy before June 30.

Here is an overview of such a strategy, in five questions.

  • What is income splitting?
    Income splitting consists of dividing a couple’s income between the spouses to reduce their overall income taxes. The spouse who is earning more transfers part of his/her income to the spouse earning less and who, as such, falls into a lower tax bracket.
  • Is it legal?
    Absolutely! The strategy is an integral part of the very stringent rules imposed by the Government of Canada.
  • What is the prescribed rate?
    The prescribed rate is the rate set by the Canada Revenue Agency and that applies to a loan granted by virtue of a job, a status of shareholder …  or an income splitting agreement. This rate has been set at only 1% until June 30th.
  • And then?
    This means that spouses can enter into an agreement whereby the spouse with the higher income lends a sum of money to the other spouse so that the return generated by that sum is taxed to the second spouse at a lower rate. For such an agreement to be approved by the Canada Revenue Agency, the loan must be made at a rate that is equal to or higher than the prescribed rate, which, at 1%, is historically very, very low. 
  • How does the couple benefit?
    Let’s say that the spouse with the higher income has large sums of money in an investment account with an annual return of 6%. He could lend part of this money, let’s say $100,000, to his spouse. By doing so, he would be transferring to his spouse an annual income of $6,000, which would then be taxed at a lower rate. Provided the interest on the loan is scrupulously paid to the first spouse every year and everything is documented, the Revenue Agency will approve the strategy.

Even better: according to the existing legislative provisions, a strategy of this kind can apply to the entire term of the loan, provided the prescribed rate is respected when the loan is made. So, this might be a rare opportunity to set up a long-term income-splitting strategy.

Having said this, it is very important that you do not interpret this article as tax advice. It is simply news that the tax advisors know about, but that the general public is not yet very aware of. To better evaluate this new option, it is best to talk to your financial advisor and, with the help of a tax expert, see if there is value in exploring it further.

Preferably before June 30th!