Reduce the family tax bill
There are, however, a few legitimate and effective ways to split taxable income with a spouse or other family members. One of the most effective strategies in a low interest rate environment is to give a loan directly to a family member or, when minors are involved, to a family trust. Provided the loan is properly structured, the beneficiary can invest the loan proceeds, with the income taxed at a lower marginal rate. Of course, one of the keys to a successful income splitting strategy is to ensure that the return on the investments is greater than the interest rate charged on the loan.
Interest rates and deadlines
Intra-family investment loans most often involve a loan between spouses, married or common-law. But this strategy can also be effective in financing the expenses of minor children, such as private school or extracurricular activities, through a prescribed rate loan to a family trust with the minor children as beneficiaries. It is a good idea to have a formal written loan agreement in place. For this strategy to work, the following criteria must be met:
Interest must be paid on the loan at a rate at least equal to the rate prescribed by the CRA (updated quarterly). If the business loan rate is lower than the prescribed rate at the time the loan is granted, that lower commercial rate can be used. You can find current CRA prescribed rates here.
In order to comply with CRA attribution rules, annual interest payments must be made to the lender no later than January 30 of the following year. Failure to do so may result in attribution of income earned on borrowed funds to the high income employee. And as a result, the income splitting strategy will no longer work.
Already have a prescribed rate loan?
Locking in the current low interest rates can look very appealing. But what if you and your spouse have implemented this strategy in the past when the prescribed rate was higher? You can still take advantage of the current lower rate to increase your opportunities for tax savings. First, your spouse will have to repay the existing loan – it is not enough to simply re-sign the loan agreement. To repay the existing loan, investments may have to be sold, which may result in capital gains. However, any gain would be taxed on your spouse and therefore the tax would be lower than if you owned the investment yourself. You can then arrange a new loan at the current lower rate and new investments can be purchased.
How it works – an example
Spouses John and Jill are in different tax brackets – John at 48 percent and Jill at 20 percent. John lends Jill $ 200,000 at a prescribed rate of 1%. Jill invests the money and earns 4%, or $ 8,000. She then pays John the $ 2,000 interest on the loan and deducts the same amount as the interest expense on the loan. Jill pays $ 1,200 in tax on the remaining $ 6,000, and John pays $ 960 on her interest income.
Here’s how it stacks up:
John would have had to pay $ 3,840 in taxes if he had invested the $ 200,000 himself.
By lending Jill money for income splitting, the family’s tax bill is reduced by approximately 44 percent to $ 2,160, which is a savings of $ 1,680.
Income splitting can be a great tax-saving strategy for families who have a pool of unregistered capital that they are willing to invest and have a spouse or other family member in a household. lower marginal tax bracket. To take advantage of income splitting, talk to your advisor, who can walk you through the necessary steps.
By Laurianne Osmak, CLU, CHS Financial Planner and Darcie Doell, Financial Advisor; Doell Osmak Wealth Phone: 306-922-2020 Email: Darcie Doell, Heritage Advisor – [email protected]
Email: Laurianne Osmak, Heritage Advisor – [email protected] Email: Michelle, Heritage Associate – [email protected]
© 2020 Manulife. The people and situations depicted are fictitious and their resemblance to any living or deceased person is purely coincidental. This material is for informational purposes only and is not intended to provide specific financial, tax, legal, accounting or other advice and should not be relied upon in this regard. Many of the issues discussed will vary from province to province. Individuals should seek professional advice to ensure that any action taken with respect to this information is appropriate for their specific situation. E&O E. Commissions, trailing commissions, management fees and expenses can all be associated with investing in mutual funds. Please read the fund facts and prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Any amount allocated to a segregated fund is invested at the risk of the contract holder and its value may rise or fall. www.manulife.ca/accessibility
 If the lender or borrower is a U.S. person (a U.S. citizen, U.S. resident, or U.S. green card holder), this strategy may have adverse U.S. tax consequences. Please speak to your advisor before undertaking this strategy.
 This is a fictional scenario for illustration purposes only. As of July 1, 2020, the rate prescribed by the CRA is 1%.