People who have watched a lot of American TV or read the US comics for years often think that married Canadians can file joint income tax returns like our American friends. “For Better or Worse,” so far we can’t. We have a type of pseudo-income splitting for some families and some seniors, but in general each person files independently and pays tax at ever-increasing rates based on their personal income. That’s led to Canadian couples searching for the best way to legally reduce their income taxes after marriage.
If the couple can keep all of their long-term savings in their
TFSAs and RRSPs, including a spousal RRSP if appropriate, then there isn’t much to worry about. Investments in these registered accounts are either not taxed ever (TFSAs) or is taxed when the money is withdrawn in the future (RRSPs.)
If the couple has additional money to invest, however, it is taxed back to whomever supplied the money that was invested. For example, a wife making twice the income of her husband cannot just give money to her husband to invest. If she does, any income or capital gains generated by that money will be taxed at her personal rate not his.
(I’m aware that the federal government recently introduced a small, maximum $2000, tax savings program for families with children under 18 which they have called income-splitting: I don’t discuss that in this article because it’s only available to a few and it is so limited as to be almost worthless. Retired persons over 65 with the correct types of income can also apply for a special income-splitting provision on their taxes. That is also not discussed here.)
So how can this couple with unbalanced incomes best invest to reduce their overall taxes?
Income Splitting Strategy 1:
Live Off the Income of the Higher Earning Spouse and Invest Some or All of the Income of the Lower Earning Spouse
If you can leave a clear trail for the CRA to follow, you can have the lower income earning spouse make all of the non-registered investments and report all of the income on their personal income tax return. For example, the spouse in the lowest tax bracket can claim
- any interest from that person’s Savings Account/s
- any interest from GICs
- any dividends, distributions, income and return of capital from stocks held in a non-registered cash trading account at a brokerage
- any realized capital gains and losses from property and stocks held in non-registered accounts
- and other sources of income.
(Note: income and gains made within a TFSA are never taxable and within a RRSP are taxed only when the cash or asset is withdrawn from the RRSP/RRIF account not at the time it is earned.)
How does this work?
The spouse with the lower income must make all of the investments from which the earnings are to be claimed.
How Can You Keep the CRA Happy?
Make the procedure clear.
To keep the CRA happy, it’s a good idea to have a clear paper trail showing the movement of the money from his/her pay cheque to the investment.
For example, if the husband earns less income, it would be best to have his pay deposited into a specific chequing account, such as a no-fee account at Tangerine or PC Financial, then moved directly from there to the investment.
The chequing account should not be used for anything except for the pay deposits and the managing of the investment income. It should NOT be used to pay regular bills or to write cheques for personal spending.
If absolutely necessary, a clearly documented transfer of part of the money out to a joint chequing account could be made.
In general, though, money should be transferred from that chequing account directly to the institution where it is deposited in a Savings Account or used to purchase GICs; or the money should be transferred or deposited into an online discount brokerage account or a managed investment account. The transfer can be electronic or by paper cheque.
For extra protection in case of an audit, in addition to the bank records, the low-income earner should keep a journal of each transaction in and out of the chequing account, what it was for and where the money came from or went.
What If We Want to Invest More than the Income of the Lower Earning Spouse?
If the lower earner is not making much money, it’s possible you’ll have more to invest than you can shelter using this technique.
(The earnings from any investments made with cash supplied by the higher income spouse must be claimed by the higher income spouse according to the CRA income attribution rules.)
Income Splitting Strategy 2: Set up a Legal Spousal Loan
In this case, you might want to consider using a fully documented Spousal Loan to move money from the higher earning spouse to the lower earning spouse.
A Spousal Loan must be made at the Prescribed Interest Rate set by the federal government. Obviously, this only has value if the Prescribed Rate is substantially lower than the expected return on the investments. However, in the past couple of years the rate has been very good.
You can read more details about this type of loan on the Blunt Bean Counter’s website.
Can We Invest the Lower Income Spouse’s Pre-Tax or After-Tax Income?
I had always assumed that Strategy 1 was limited to investing the lower-income spouse’s after-tax income. However, in the book, “How to Eat an Elephant” the author Frank Wiginton states one should have the higher-income spouse “pay all the bills and expenses, including the income taxes of the other spouse, so that all the income of the lower-income spouse can be put toward investments.”
In other words, he says you can use the lower-income spouse’s pre-tax income!
I tried to check whether this was accurate or not.
Some other sources appear to agree. For example in an article by Deb MacPherson in the Financial Post it states
“You can also directly pay your spouse’s income tax bill. Simply make sure the cheque is drawn on your own account. The funds your spouse would otherwise use to pay taxes can be invested and the income will be taxed in his or her hands.”
It states: “Deb MacPherson is leader of KPMG Enterprise’s tax practice in Canada. She is based in Calgary.”
Before assuming this is true, I would check with your own accountant to make sure that the CRA has not changed any rules recently.
- Deliberately Misleading Government Ads About Tax Breaks Anger No-Young-Children Canadians Needlessly
- One Reason Why Spousal RRSPs Are Useful
- Spousal Loan Pitfalls includes info on when a spouse dies or divorces
Do you invest to try to reduce your overall income tax paid as a couple? Or are your incomes so closely matched that there is no benefit to be won? Please share your own strategy with a comment.