In­come split­ting a dan­ger­ous tax game

If you don’t know the rules

The Expositor (Brantford) - - BUSINESS - JAMIE GOLOMBEK

With top mar­ginal tax rates over 50 per­cent in seven out of­ten­temp­ta­tion to shift in­come from a higher-in­come fam­ily mem­ber to a lower-in­come spouse, part­ner or child has never been greater. In­deed, the spread be­tween the top rate (over 53 per cent in On­tario) and the low­est rate (as low as 20 per cent in B.C. and On­tario) has cre­ated ripe op­por­tu­nity for in­come split­ting. But be­ware, be­cause if you don’t un­der­stand the com­plex rules sur­round­ing what is and isn’t al­lowed, you could find your­self caught by the at­tri­bu­tion rules or, worse still, fac­ing off against the tax man in court, a route one tax­payer re­cently tried.

In­come split­ting can be for­mally de­fined as trans­fer­ring in­come from a fam­ily mem­ber to a lower taxed fam­ily mem­ber to re­duce the over­all tax bur­den of the fam­ily. Since our tax sys­tem has grad­u­ated tax brack­ets, by hav­ing the in­come taxed in the lower-in­come earner’s hands, the over­all tax bill of the fam­ily can be re­duced.

Our In­come Tax Act has a va­ri­ety of anti-avoid­ance rules meant to block at­tempts at in­come split­ting. These are tech­ni­cally known as the at­tri­bu­tion rules be­cause they at­tribute the trans­ferred in­come back to the orig­i­nal source, or the trans­feror.

For­tu­nately, there are sev­eral ex­cep­tions to the at­tri­bu­tions rules that not only per­mit but, in some cases, en­cour­age us to split in­come. For ex­am­ple, if you give your mi­nor kids money to in­vest, any in­ter­est or div­i­dends earned on those funds will at­tribute back to you, but not any fu­ture cap­i­tal gains. On the other hand, if you gift funds to your spouse or part­ner for in­vest­ment, all fu­ture in­come as well as cap­i­tal gains will at­tribute back to you. If, rather than a gift, funds are loaned be­tween spouses or part­ners at a min­i­mum of the Canada Rev­enue Agency’s pre­scribed rate (cur­rently set at two per cent un­til at least the end of 2018), the at­tri­bu­tion rules won’t ap­ply, pro­vided the in­ter­est on the loan is ac­tu­ally paid by Jan. 30 of the fol­low­ing year.

But per­haps the eas­i­est way to split in­come that ac­tu­ally in­volves no phys­i­cal trans­fer of funds is the abil­ity that spouses (or part­ners) have to split pen­sion in­come. Pen­sion in­come split­ting can re­sult in sub­stan­tial tax sav­ings if one spouse is in a lower tax bracket and it can also help pre­serve Old Age Se­cu­rity ben­e­fits, which might be clawed back if the re­cip­i­ent part­ner’s in­come is above the claw­back thresh­old ($75,910 for 2018). Pen­sion in­come split­ting may also al­low dou­bling up on the $2,000 fed­eral pen­sion in­come amount if the sec­ond spouse doesn’t have their own pen­sion. It can even help pre­serve the age amount, which pro­vides a non-re­fund­able credit for tax­pay­ers over age 65, but which is re­duced once in­come is over $36,976 (fed­er­ally).

Any pen­sion in­come that qual­i­fies for the fed­eral pen­sion in­come credit also qual­i­fies to be split. Specif­i­cally, this would in­clude an­nu­ity-type pay­ments from an em­ployer-spon­sored reg­is­tered pen­sion plan, re­gard­less of age, and also in­cludes Reg­is­tered Re­tire­ment In­come Fund (RRIF) or Life In­come Fund with­drawals, but only upon reach­ing age 65. (In Que­bec, you must be at least 65 to split any of your pen­sion in­come.) It does not, how­ever, in­clude RRSP with­drawals, which is why Monc­ton res­i­dents David and Deb­o­rah Way found them­selves in Tax Court last month ap­peal­ing their 2015 tax re­assess­ments.

In 2015, Mr. Way made two lump sum with­drawals from his RRSP to­talling $15,482. He did so with­out in­tend­ing that these with­drawals be con­verted into an an­nu­ity or a RRIF. In their 2015 re­turns, Mr. and Mrs. Way jointly elected to split this to­tal of $15,482, which was re­ported in their 2015 in­come re­turns as “pen­sion in­come.” Each of the two spouses re­ported $7,741 (half of the $15,482) as in­come from an RRSP.

The CRA as­sessed the re­turns, deny­ing the joint elec­tion to split the RRSP in­come on the ba­sis that Mr. Way, in his 2015 tax­a­tion year, did not re­ceive any “el­i­gi­ble pen­sion in­come.” As a re­sult, he was as­sessed the en­tire $15,482 RRSP with­drawal as in­come, and also was dis­al­lowed $1,161 of the age amount he had claimed in com­put­ing his non-re­fund­able tax cred­its. To make mat­ters worse, he was also de­nied the fed­eral pen­sion amount of $2,000 he had claimed for the same rea­son — he sim­ply had no “el­i­gi­ble pen­sion in­come” in 2015 be­cause with­drawals from his RRSP it­self do not con­sti­tute “pen­sion in­come” as they were not pay­ments from a pen­sion life an­nu­ity or RRIF.

Sur­pris­ingly, how­ever, Mr. Way was not in court to chal­lenge these as­sess­ments. Rather he tes­ti­fied that he had pre­pared his and Mrs. Way’s 2015 re­turns us­ing a tax soft­ware pro­gram that was “cer­ti­fied by Canada Rev­enue Agency.” He tes­ti­fied that he “had ac­cu­rately used this pro­gram but that the pro­gram was faulty be­cause it led him to this er­ror in pre­par­ing the two tax re­turns, and con­se­quently his tax re­assess­ment in­cludes in­ter­est at a sub­stan­tial rate go­ing back to 2015.”

He was in court to seek dam­ages from the soft­ware provider and/ or the CRA, which cer­ti­fied the soft­ware, “aris­ing from ex­penses he has in­curred” (pre­sum­ably the non-de­ductible ar­rears in­ter­est) from what he claimed was “faulty soft­ware.”

Un­for­tu­nately, as the judge sym­pa­thet­i­cally ex­plained, the Tax Court “does not have ju­ris­dic­tion for such claims .... In New Brunswick the New Brunswick Small Claims Court and the New Brunswick Court of Queen’s Bench likely have the re­quired ju­ris­dic­tion for a claim of the na­ture Mr. Way says he wishes to pur­sue.”

Reached by phone this week, Mr. Way said he hasn’t con­tacted the soft­ware com­pany and, at least at this junc­ture, would not be tak­ing his case any fur­ther as it “is not cost ef­fec­tive to pur­sue. The le­gal sys­tem is not very help­ful for the lit­tle guy. You have to hire lawyers, spend time and ag­gra­va­tion.”

As for con­tin­u­ing to rely on tax soft­ware to pre­pare his own re­turns, Mr. Way said that af­ter this ex­pe­ri­ence, “I went back to an ac­coun­tant and paid my $360.”


If you gift funds to your spouse or part­ner for in­vest­ment, all fu­ture in­come as well as cap­i­tal gains will at­tribute back to you.

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