Income splitting is a tax technique used in Canada to distribute money to family members with lower incomes, hence lowering a taxpayer’s overall tax burden. Using Canada’s progressive tax system, which levies higher tax rates on higher income levels, is the premise behind income splitting. Taxpayers can effectively minimize their overall taxable income and lower their tax obligation by allocating income to family members who have lesser incomes.
Rules and Methods for Income Splitting In Canada:
Spousal Loans
This entails making a loan with interest to a spouse or common-law partner who earns less money. After that, the spouse with the lower income can claim the interest income, thereby dividing the taxpayer’s income.
Family Trusts
A family trust is a kind of trust that enables the revenue it generates to be distributed to various family members. Taxpayers can distribute income to family members with lower incomes through the use of a family trust, which lowers their overall tax burden.
Investment Income Splitting
This entails holding investments in the names of relatives with lower incomes. The proceeds from these investments can subsequently be claimed as income by the family members with lower incomes, splitting the taxpayer’s earnings in two.
Working of Income Splitting in Canada in 2023:
The tax on split income (TOSI), which previously only applied to gains from split income for people under the age of 18, will now also apply to split income for those over 18.
The dividend income of all individuals over 18 will be taxed at “the highest marginal tax rate,” according to the Canada Revenue Agency (CRA). The new regulations effectively eliminate the possibility of using income splitting with a family member in a lower tax band to benefit from lower tax rates.
Exemptions from TOSI in Canada Income Splitting:
Excluded Business Gains
Gains are excluded from tax on split income (TOSI) if the family member was employed by the company for an average of at least 20 hours per week in the most recent tax year and is between the ages of 18 and 24.
Additionally, you only need to show the family member’s work input during the time that the company is open (say, six months out of the year). Dividend earnings made after the tax years the person worked are also exempt from TOSI, in addition to earnings earned during those tax years. When you want to change a single proprietorship into a corporation, this is useful.
Excluded Shares
Dividends received by a relative who is at least 25 years old and who owns at least 10% of the voting and market value of the business are not subject to TOSI. Finance Canada clarifies that this exemption will only be available to businesses that “earn less than 90% of [their] revenue from the provision of services” and are not professional corporations, like medical and dental offices.
Final Words
It’s crucial to remember that while income-splitting strategies are successful in Canada, they must be carried out in accordance with the country’s tax laws and regulations. The CRA has restrictions to stop filers from artificially using income splitting to lower their tax liability, and those who do so risk penalties and fines. Income splitting is a great strategy to use if you’re searching for ways to lower your taxable income in Canada.
