Income splitting means less taxes...... right?

Allowing couples to pool their income at tax time sounds good, but some contend the Tory promise won’t offer families relief — it will just further widen the income gap

Ottawa has promised to introduce a new way for middle-income Canadians to pay less tax, a carrot that the Harper government is dangling for next year when the federal budget is balanced.

The tax break would come through something called income splitting for families, a pretty simple idea that lets couples pool their income for tax purposes. It is a way to cut their tax bill and can have a powerful effect.

The late Jim Flaherty backed away from the promise shortly before he stepped down as finance minister in mid-March. His successor, Joe Oliver, is committed to “greater tax relief for families” but it’s still unknown what form that it will take. On March 26, soon after taking over from Flaherty, he said during Question Period in the Commons that “income splitting was a good policy for Canadians seniors and it will be a good policy for Canadian families.”

Critics contend that to extend income splitting to families would be a gift to the country’s most affluent households and make income inequality worse. A report by the Canadian Centre for Policy Alternatives has argued that 86 per cent of Canadian families would not benefit from the proposed tax change, while it would cost taxpayers almost $5 billion.

Under current rules, seniors with pensions have the greatest opportunity to split income, while the rest of us are excluded. The biggest benefit comes when one spouse earns most of the family income, or there is a big gap between the two incomes. Income splitting lets the spouse in the higher tax bracket transfer some income to the spouse in the lower bracket, cutting the overall family tax bill.

“The category missing is your average hardworking Canadian,” says Frank Di Pietro, director of tax and estate planning at Mackenzie Investments. “There’s really no way for that individual to shift income to a spouse or partner. It’s been neglected.”

Here’s a simple example of how big a deal this can be. It looks at two couples with the same income. One pays $9,000 less in taxes. Here’s how:

Couple 1: Miriam makes $100,000 a year, while her spouse is a stay-at-home dad. Couple 2: David and Daphne each make $50,000.

Miriam’s income puts her in the second highest tax bracket, which kicks in after you make $87,907 a year. So she will pay roughly $26,400 in tax, using 2014 federal and Ontario tax rates.

David and Daphne will collectively pay about $17,400, since both their salaries fall into a lower tax bracket than Miriam’s. So Miriam pays the extra $9,000 in tax, even though the two couples have the same family income.

The reasons this happens, says Di Pietro, is because the progressive tax system is based on the notion that as “our income levels rise, so do our tax rates.”

The Harper government may fix this tax discrepancy — just in time for a federal election — by allowing couples with children under 18 to split up to $50,000 of their income. In our scenario, Miriam could in that case split her income with her partner, putting them into the same lower tax bracket as David and Daphne.

In the meantime, here are some ways you can share income now:

Pensions:

If you have a defined benefit pension plan from your employer, you can transfer up to 50 per cent of that to your spouse or common-law partner.

It’s worth doing if the spouse has low income, says Di Pietro. You would split the pension amount when doing your annual income taxes. CPP benefits: Pensioners can split half of their Canada Pension Plan benefits with a spouse or partner.

You must apply for this, and the Canada Revenue Agency will split CPP amounts once it has received a completed pension-sharing form ISP1002. This works best when one spouse is in a higher tax bracket than the other. Spousal RRSPs: The spouse with the higher income makes an RRSP contribution for the lower-earning partner. The high-income earner gets the deduction and the tax savings. But the contributions and RRSP belong to the lowerearning spouse, who can withdraw the funds at a much lower tax rate. “This makes sense when a spouse is in a lower income bracket or expects they will be in retirement,” Di Pietro says. Investment income: A spouse can also income split in- vestment income with another spouse or child. “Over time one spouse tends to accumulate the investment assets, so you may have a pool of investments that is in the name of the individual who pays tax at a higher rate,” Di Pietro says. Splitting investment income involves detailed tax planning that’s best handled by an accountant, he adds, since there are rules about gifts versus loans and the consequences of capital gains. “It’s not just ‘put your spouse’s name on investment account and now we can income split with the money.’ It goes far deeper than that,” he says. Self-employed professionals: They can hire family members — their spouse and/or children over age 18 — and pay them a reasonable salary. “It’s a way of shifting income to family members who might be paying tax at a low rate,” Di Pietro says. Incorporated business owners: Family members can be brought on as shareholders and can be paid dividends, similar to how those who own dividend-paying stocks are compensated.