Accountants often call the income splitting rules attribution rules. The term attribution simply means to attribute income back to the original person and effectively stop any attempt to income split.
Who Do The Income Splitting Rules Apply To?
The rules that are designed to prevent income splitting apply when you attempt to shift income to any one of the following people:
- Your spouse or common law partner,
- Any person who is under age 18 and are your children, grandchildren, nieces and nephews.
- Any person you are not dealing with at arms length, and
The rules are applied differently for each type of person listed above.
Income Splitting Between Spouses
The income splitting rules were designed to prevent you from giving your money or using a joint account to split income. If you do transfer property (for example, stocks) to your spouse directly or indirectly, the Income Tax Act says:
- The transfer is at your original cost, and
- All income and future gains will continue to be taxed your hands.
In the end, there is no tax when you transfer ownership and you continue to pay the tax just as you always had. More and more online bookkeepers are making these processes much more accessible to people with less education on this.
As luck would have it, you can still income split with your spouse if:
- Your spouse purchases the property from you with their own funds and at fair market value, or
- You lend the funds to your spouse to purchase the property from you using a note with interest payable at the prescribed rate.
Pension Income Splitting
If you are receiving payments from a defined benefit pension plan or are 65 or older and have pension income, you may be able to split that income with your spouse or common law partner.
Income Splitting With Children
The income splitting rules are a little different when it comes to children under the age of 18. As mentioned above, these rules apply if you give or lend income producing property such as stocks or other investments to a minor who is your child, grandchild, niece or nephew.
When you transfer property to a minor, the Income Tax Act says:
- The transfer is deemed to be at fair market value, and
- You will continue to be taxed on income such as interest, dividends, rents and royalties, until the child is 18.
When you give or transfer property to a child, you will have a capital gain or loss and all future gains and loses are taxed to the child. However, you still have to pay tax on the investment income until the child turns 18.
You may e able to get around the investment income attribution if the child purchases the property from you at fair market value and pays with their own funds.
Tax on Split Income (Kiddie Tax)
The so-called kiddie tax was introduced to reduce some of the benefits of other types of arrangements such as family trusts by applying the top marginal tax rate to all income. In addition, this income is also not eligible for deductions or tax credits (other than the dividend tax credit).
There are a number of pitfalls that can result from these types of arrangements and professional advice should be sought.
Secondary Income Can Be Split
When the income splitting rules do apply, they will only affect the first generation received from the initial transfer. Income earned from reinvestment of the first generation income is not subject to the attribution rules.
For example, if $1,000 of interest was subject to the income splitting rules and taxed in your hands, then income earned from the re-investment of the $1,000 would not.
Other Rules Affecting Income Splitting
- If a spouse or minor child has an existing commercial rate loan, a new loan or interest free loan cannot be substituted.
- The Income tax Act does not permit funds to be lent to an unrelated third party who then lends the funds to the spouse or related minor.
- A loan guarantee cannot be used to avoid the income splitting rules. A higher income spouse cannot avoid the rules by providing a loan guarantee on a low rate or interest free loan to a spouse.
- There is a variety of other rules in the Canadian Income tax act designed to prevent income splitting through a trust or corporation.
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