Income Splitting Strategies for Families
Written by Jim Yih •
Income splitting is really the strategy of trying to give income that will be paid at a higher tax rate to someone that is in a lower tax rate. To look at some different income splitting strategies for families, lets take a look at Jack and Nancy and how they were able to achieve effective income splitting in their household.
Nancy runs a very successful jewelry business and personally earns about $150,000 per year. Jack is semi retired doing some consulting work and he makes about $12,000 per year consulting. He spends the rest of his time helping with the family, driving the kids to their activities and helping with the restaurant whenever he is needed. They share a bank account and pay all their family expenses out of that account. They have three kids under the age of 15.
Pay Jack and the kids out of the business.
Salary and wages are a deductible expense when it comes to legitimate services and work being performed. Jack helps with the books and the financial aspects of the business. He also finds himself running around doing little errands for Nancy when needed. Nancy pays Jack about $30,000 per year for his work for the business. Since Jack’s income is only $12,000 form consulting, it is advantageous to pay Jack because this $30,000 will be taxed at 26% to 32% instead of Nancy taking it out at 39%. On weekends, the kids also come the the restaurant before it opens and helps clean and get things ready for the day. They also deliver flyers to the neighborhood houses and sometimes help clean dishes in the kitchen for a little extra cash. Nancy believe paying the kids is not only good for income splitting purposes but also to teach them the value of working for money.
Paying your spouse or children for legitimate work, can be a great strategy go get income into family members with lower incomes.
Registered Education Savings Plans (RESPs)
RESPs are considered a form of income splitting because the investment income is taxed in the hands of the children at the time of withdrawal instead of being taxed in the hands of the contributors (usually the parents or grandparents) as earned. By contributing $2500 (according to the new budget) each into each of their kids RESPs, any growth on the money will be taxed in their names when the money eventually comes out. The incentive in using the RESPs is that the government will contribute 20 cents for every dollar Nancy and Jack put into the plan. On a $7500 contribution, the government will put in $1500 towards their education in the form of the Canada Education Savings Grant.
Invest in the lower income spouses name.
On top of maximizing RRSP contributions, Nancy and Jack are saving about $30,000 per year towards their retirement. Instead of pooling their income and investing the $30,000 together like most people do, here’s how Jack and Nancy can save a few bucks on taxes. Jack should set up a separate bank account for his income including the income he makes from the business. Jack should then save the $30,000 from his account and all family expenses should be paid out of the joint or Nancy’s account. The advantage to this strategy is any investment income earned on the $30,000 will be taxed in Jacks lower income instead of Nancy’s higher income. The more money they save, the more tax savings they will have.
Although Jack and Nancy do not represent all families, most families have some opportunities to implement income splitting strategies. There are many more opportunities to save money through effective tax planning. If you are not sure about how these income splitting strategies or others apply in your situation, be sure to seek the advice of a professional.