As you review your income tax return this coming month, you might notice that you and your spouse have very different amounts of taxable income. If one of you is below $43,000 taxable and the other is above $87,000 taxable, then read on.
In a situation like this, the lower income spouse - we will call him “Bob“- is paying a much lower rate on investment income. Bob’s combined federal and provincial tax rate is zero to 28% on interest income, while only zero to 6.5% on eligible dividends paid on any company shares that Bob owns.
On the other hand, Bob’s high income wife Sally is paying 43.4% to 46.4% on interest income, and 28% to 32% on eligible dividends.
Obvious answer? Claim all of the investment income earned by either of them on Bob’s tax return.
Problem? This may be in clear violation of the Canada Revenue rules, which state that the investment income must be claimed by the person who earned the investment income. These are generally called the “attribution rules.”
Even if these investments are in a joint account, if most or all of the investment capital came from Sally’s earnings, then it is Sally who must claim the investment earnings on her income tax return. (Sorry about that.)
Solutions? There are several, and the appropriate one will depend on how much investment capital we are talking about.
Step one for a couple in Bob and Sally’s situation is for the lower income spouse to save and invest all of his or her income if possible. In a perfect situation, the higher income spouse’s income is enough to pay for all family expenses and income taxes, plus make the family RRSP contributions (deductible to the higher income spouse as contributor, but usually into the name of the lower income spouse as “annuitant” or owner of the plan), and also make the TFSA contributions.
The lower income spouse then accumulates all of the non-registered investments in his or her name.
Having made adjustments for any future pension income that might be available to the lower income spouse, the goals are to try and limit any investment income taxable in the higher income spouse’s name, and in the long run, equalize retirement incomes to limit tax in retirement.
In the wonderful situation where the higher income spouse has significant non-registered investment capital, whether from savings, exercise of stock options, sale of the business or inheritance, there are two faster strategies.
Immediate relief is available thanks to low interest rates and CRA returning their “prescribed rate” to just 1%. This is the rate that Sally (the lender) would have to charge Bob or a family trust (the borrower) if she loaned investment capital to invest in his name, and thus avoid the attribution rules.
For example, if Sally loans Bob $100,000 to invest, Bob must actually pay Sally $1,000 of interest each year, within 30 days of year end. This $1,000 is taxable to Sally and deductible to Bob.
Bob then invests the $100,000 and earns, let’s say, 4% dividends and a few percent each year in capital gains, by investing in mature company shares.
You do the math over any number of years and you can see the advantage.
The other, slower strategy is for Sally to gift the money to Bob, but she remains responsible for the tax on the investment income earned on the original amount gifted. However, Bob can siphon off the dividends, interest or capital gains earned, and invest in an account that will be his forever (at least for tax purposes).
These rules also apply when the lower income family member is a child or grandchild. Any of these strategies must be done properly, so please consult your professional advisors first.
And remember, “spring” is just around the corner!
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIMis a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.