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TAXFlash News from IncomeTaxCanada.net
:: Income splitting great way to legitimately reduce taxes and increase your return on investment … but only if done exactly as prescribed by the CCRA
:: Get yours while the going is cheap – income splitting that is. For certain couples (married or common-law) a small window of opportunity is open to legitimately split income on the cheap. The window for cheapskates is open a crack due to our historically low interest rates that appear to be on the rise. Believe it or not, the seed for this income splitting opportunity is found in how CCRA sets its base interest rate known in talk lingo as the prescribed rate. The prescribed rate is used to, among other things, calculate interest on overdue taxes and calculate various taxable benefits. CCRA sets the prescribed rate each quarter (January 1, March 1, July 1 and October 1) based on the average interest rate on 90-day treasury bills during the first month of the preceding quarter. As a point of interest, CCRA tacks an extra 4 per cent onto the prescribed rate for overdue taxes while paying a meagre 2 per cent above the prescribed rate when CCRA owes money to taxpayers – no surprise there! Anyway, the current prescribed rate is a mere 2 per cent, although CCRA has already announced that this will increase to 3 per cent effective July 1. Interest rate gurus are also predicting further interest rate increases in the future which spells further increases in the prescribed rate. This means you have 15 days to set things up if you want to take advantage of the benefits income splitting can provide at the lowest possible cost in recent memory. Without getting into all the details, CCRA has a complete and complex set of rules known as the “attribution rules” designed to quell most income-splitting arrangements including the types most often employed by the do-it-yourself crowd. For example, if you give money to your spouse who then uses the money to purchase an investment, the attribution rules say that the income earned thereon is to be taxed to you and not your spouse thereby thwarting your original income-splitting intention. But with some very precise stickhandling there is a way around the attribution rules enabling taxpayers to establish legitimate income-splitting arrangements. The basis for this opportunity is actually found within the attribution rules themselves where, in laymen’s terms, it states that the rules don’t apply where loans to a spouse bear interest at the “prescribed rate” and that interest is actually paid within 30 days after the end of the year. Hmmm. In other words, it’s perfectly okay to lend your spouse money as long as the loan bears interest at the prescribed rate and your spouse actually pays the interest so charged by no later than January 30 of the following year.
The ownership of the funds to be loan should be indisputableConsider the case of Mrs. Supra Income and her husband, Mr. Lowell Income. Mrs. Income is in the highest income tax bracket unlike her husband, Mr. Income, who pays income tax at the lowest rate. Mrs. Income has $10,000 she wishes to invest. The best investment she can find has an expected yield of 7 per cent per annum providing her with $700 of income during the year. Of course the taxman will want his take (about $306 at the highest tax rate) so this investment will leave Mrs. Income with a net after-tax return of $394. As an alternative, what if Mrs. Income provides a $10,000 loan to Mr. Income charging interest at a rate of 2 per cent per annum on the funds advanced? Mr. Income uses the borrowed money to purchase the same investment yielding 7 per cent. During the year Mr. Income pays $200 of interest to Mrs. Income but he receives $700 of interest from his investment leaving him with a net of $500 to the good. At the highest personal tax rate, Mrs. Income will have to pay income tax of approximately $87 on the $200 of interest income she received from Mr. Income during the year. Mr. Income will also have to pay tax on the $700 of income he received from his investment but, because he used the borrowed funds for investment purposes, he will be allowed to claim a deduction of $200 for the interest he paid to Mrs. Income. The income tax Mr. Income will pay on his $500 net return will be roughly $110 at the lowest marginal tax rate. Tallying up the overall tax bill, Mr. and Mrs. Income find the total tax paid has dropped to $197 leaving them with a net after-tax return on the same investment of $503. This represents a saving of $109 over the first option whereby Mrs. Income purchases the chosen investment directly. The saving has been realized because Mrs. and Mrs. Income have split their income to take advantage of Mr. Income’s lower personal tax rate. This is an obvious but key point to understand – income splitting only works where spouses are in different tax brackets and the further apart the two tax brackets are the better. As is always the case in tax driven transactions, setting up and maintaining the structure is absolutely paramount. Mess it up and the whole thing will collapse like a house of cards. The ownership of the funds to be loan should be indisputable – the money to be loaned must clearly be the property of the higher income earner. The individual providing the loan should write a cheque on his or her personal bank account (not a joint account) payable to the lower income spouse. A written, signed loan agreement such as promissory note should be put in place to document the loan. As previously indicated, interest must be paid at the prescribed rate (that’s 2 per cent until the end of this month) on the borrowed funds no later than 30 days after the end of the year. To play it safe, put the loan on autopilot and have the bank transfer the required payment each month. The borrower should deposit the funds to his or her chequing account subsequently writing a cheque to purchase the desired investment. Each year the spouse who made the loan should include the interest income received in his or her income. The borrowing spouse should deduct the same amount of interest as an expense to earn investment income in addition to reporting the income received from the investment. Done right this 2 per cent solution can remain in place for as long as you desire but if you want to do the deal on the cheap you’d better get your act in gear and fast.
Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney Official details about this and other topics on income taxes can be found in English & Francais at www.ccra-adrc.gc.ca Income tax information offered by www.IncomeTaxCanada.net is done so without endorsement by Canada Revenue Agency (CRA) - l'Agence du Revenu du Canada (ARC) (formerly Canada Customs and Revenue Agency - l'Agence des Douanes et du Revenu du Canada CCRA-ADRC and formerly Revenue Canada – Revenu du Canada) or any Canadian government agency. The free advice is of a general nature for Canadian taxpayers seeking legal ways to reduce their personal and small business income taxes payable to the federal and provincial (or territorial) governments in Alberta, British Columbia, Manitoba, New Brunswick Newfoundland-Labrador, Northwest Territories, Nova Scotia, Nunavut, Ontario, Prince Edward Island, Quebec, Saskatchewan or Yukon. Specific taxation situations vary from taxpayer to taxpayer, province to province, territory to territory. The free tax advice here is only a general guide. Canadians should always seek individual guidance on accounting rules and tax laws from knowledgeable accountants and lawyers. To prepare your income tax return online and NetFile your Canadian income taxes electronically in English or Francais, please visit www.ufile.ca or www.impotexpert.ca websites. Additional information on financial products and services for Canadians can be found at www.CanadianCreditCenter.com. |
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Jim Maroney