Split income in Canada refers to the practice of dividing income between family members in order to potentially reduce tax liabilities. This strategy allows high-income earners to allocate a portion of their income to lower-income family members who may be taxed at a lower rate. Splitting income can result in significant tax savings for families who have a large discrepancy in income levels.
The concept of split income is based on the principle of income attribution, which is the notion that income earned by one individual should be attributed or assigned to another individual for tax purposes. In Canada, income splitting is governed by specific tax rules outlined in the Income Tax Act.
The Canadian tax system is designed to be progressive, meaning that individuals with higher income levels are subject to higher tax rates. By splitting income with family members, high-income earners can potentially lower their overall tax burden by taking advantage of the lower tax brackets of their lower-income family members.
There are several different methods of splitting income in Canada. One common method is to pay dividends to family members who are shareholders of a family-owned corporation. Dividends are generally subject to a lower tax rate than employment income, making this an effective strategy for income splitting.
Another method is to loan funds to a lower-income family member at a prescribed rate of interest. By charging interest on the loan, the high-income earner can shift income to the lower-income family member who is taxed at a lower rate. This approach is commonly referred to as an income-splitting loan or a prescribed rate loan.
Additionally, contributions to a retirement savings plan, such as a Registered Retirement Savings Plan (RRSP), can also help with income splitting. Contributions to an RRSP are based on earned income, so making contributions for a lower-income spouse can help equalize income levels and potentially reduce overall tax liabilities.
It’s important to note that while splitting income can be a beneficial tax planning strategy, there are specific rules and restrictions in place to prevent abuse. The Canadian government has implemented what is known as the “kiddie tax” or the tax on split income (TOSI) to limit the extent of income splitting for certain family members, particularly children under the age of 18.
The TOSI rules aim to prevent high-income earners from shifting significant amounts of income to minor children who may not be actively involved in the family business or investment decisions. Under these rules, certain types of income received by minors, such as dividends from private corporations, can be subject to more punitive tax treatment.
It’s important for individuals considering income splitting to be aware of these rules and consult with a tax professional to ensure compliance. Failure to comply with the TOSI rules can result in significant penalties and additional tax assessments.
Overall, the concept of split income in Canada provides families with an opportunity to reduce their tax burden by redistributing income among family members. This can be particularly beneficial for families with significant income differences. However, it is important to understand and comply with the applicable tax rules and restrictions to ensure that income splitting is done within the confines of the law. Consulting with a tax professional is highly recommended to navigate the complexities of income splitting and maximize its potential benefits.
