Tax Brief: Reduce Taxes via Family Income and Allocation Planning
A great question we always receive from clients working on their family tax planning strategies is “how can we reduce taxes?” Tax-splitting strategies are used to move taxable-income from the higher tax bracket family members, to members at lower tax-brackets. Clients have been able to save thousands of dollars, via the use of efficient tax planning methods however, this does not mean that it’s an easy objective to achieve. The Canada Revenue Agency (“CRA”) has implemented strict rules to prevent Canadians from reducing their overall tax burdens, via previously successful tax planning techniques.
One major factor in setting up a successful family tax-splitting strategy is avoiding attribution. Once attribution scenarios are avoided, a clear tax planning strategy can be created. So what is attribution? The Act provides that where an individual (“transferor”) has transferred or loaned property or money for the benefit of another (“transferee”), any resulting income or loss will be “attributed” or picked up on the tax return of the transferor. Therefore, even though the transferee (presumably, paying taxes at the lower tax rate) receives the income, the income will be taxed on at the tax rates of the transferor. The result of this will negate any tax planning objectives.
Therefore, in order to avoid attribution, one must be aware of what income can be attributed.
Transfers/loans to spouse: interest/dividend income or loss and capital gains or losses will be attributed
In the event of a relationship breakdown, attribution will only occur in regards to capital gains, unless a joint election is made
Transfers/loans to child:
Minor child: interest/dividend income or loss will be attributed however, capital gains or losses will be taxed at the transferees marginal tax rate
Adult child: there is no attribution on either interest, dividends or capital gains or losses.
Transfers/loans to other family members: if the main reason for the transfer/loan was for tax splitting objectives and the loan does not charge interest at the CRA’s prescribed rate, attribution may occur.
Transfers/loans to trusts: attribution depends on structure of the trust, who owns the trust, how it is funded, types of investments, who receives the distributions, timing of when distributions are paid out to beneficiaries etc. However, due to high taxation rates of trusts in Canada, tax splitting strategies involving trusts are effectively eliminated, unless
With the attribution rules in mind, where have clients been able to save thousands of dollars via successful tax-splitting? The following are some areas that clients continuously succeed in achieving significant tax-savings:
CPP and pension income splitting: income can be split between spouses. Eligible pension income includes: annuity payments, registered retirement plans, deferred profit sharing plans, payments received as a result of the death of a spouse etc
Reasonable salaries: reasonable salaries may be paid to enable income splitting. However, the “reasonableness” of salaries is something that you should review in advance, with your tax accountant and legal advisors, to avoid attribution
Higher-earning spouse pays bills while lower earning-spouse invests: enabling the lower-earning spouse to invest, will enable the family to generate more income at their lower tax rates
Reinvestment of income earned from attributable money/property: second-generation money is not attributed back to the transferor
Prescribed rate loans: as long as the interest rate is at the CRA’s prescribed interest rate amount and interest is paid annually by the required date, no attribution will occur
Spousal RRSPs: contributions towards a spouses RRSP are tax deductible by the transferor and taxed at the transferee’s marginal rate when withdrawn, unless the transferee withdraws the funds within three years of the original contribution (exception applies if the RRSP is converted to a RRIF)
RESPs and RDSPs: income will be taxed at the beneficiary’s marginal rate
TFSAs: due to their tax-free nature, no attribution will occur. However, must keep contributions in-line with the total allowable limit, to avoid penalties
Canada Child Benefit: this non-taxable amount is considered funds of the children and therefore, investment income from CCB amounts can avoid attribution, if appropriate investment structuring is used
Educational payments: if a spouse is attending higher-educational schooling, transferor should set up a loan, for the education amounts to be repaid later
Shifting of assets between spouses: income generating assets may be transferred between spouses however, to avoid attribution, transfer must occur at fair market rates
Payment of interest-bearing debts on behalf of a spouse: for interest-bearing debts unrelated to generating investment income, interest payments by a spouse are not attributable
Even though the CRA has moved to close income-splitting techniques, the average Canadian taxpayer still has many options available to establish family tax-planning strategies to save themselves thousands of dollars a year. Tax-planning strategies should involve expert tax accountants and lawyers, to ensure that any strategy falls within the CRA allowable framework and thereby, avoid costly attribution.
Questions in how the above matter may relate to you? Reach out to Blumenfeld Woznica & Co to see how this matter may impact your specific accounting and/or tax situation.
This publication is provided as an information service and may include items reported from other sources. We do not warrant its accuracy. This information is not meant as account/tax opinion or advice.