Putting tax strategies into place could help you save money in today’s economic environment.
When it comes to tax minimization, look into strategies that reduce not only your tax bill but also that of your family as a whole. One way of doing this is income splitting between family members.
Income splitting is shifting income from a family member with a high tax rate to another who will pay tax at a lower rate. Attribution rules of the Income Tax Act state that if you give a spouse funds for that person to invest. Any income or capital gains generated on those funds will be taxed in the hands of the other spouse. Similar rules apply for gifts to minors, with a few differences.
A way to steer clear of the attribution rules is by, for example, creating a loan between the spouses at an interest rate equal to or greater than the CRA prescribed rate. The loan must be documented in writing.
Today, the CRA prescribed interest rate is at the lowest possible rate of 2%. The rate will remain as such until September 30, 2022. This represents an excellent planning opportunity to allow family members to income split. The net effect will be that any investment return generated above 2% will be taxed in the hands of the lower-income family member. Now is the last chance to lock in this 2% rate, as starting October, it will increase to 3%.
Example of how to save money with this tax strategy:
Assume Mary and John are married. Mary is a successful business owner currently paying tax at the highest income tax rate, which in Ontario is 53.53%. On the other hand, John has no income.
Mary currently has $2 million of investable assets, generating a 5% return on investment. The investment income of $100,000 is taxed at the top marginal rate for her.
Mary decides to loan her near-cash investment assets to John. They document a loan agreement at the prescribed interest rate of 2%. Note there may be capital gains/losses on any dispositions. John goes ahead and invests the $2 million. At the end of the year, he generates $100,000 of investment income, assuming the same 5% rate of return. He will end up paying tax at his marginal income rate of under 15%, rather than the higher rate of 53.53%.
By January 30 of the following year, and every year the loan is outstanding, John has to pay interest of 2% on the loan from Mary ($40,000). Mary reports this $40,000 as income on her personal income tax return. John deducts this $40,000 as an interest expense on his return. Tax savings for the spouses can be over $20,000 for the first year, and available after that on an annual basis.
Something to keep in mind is that the interest rate will be 2% for the life of the loan. The interest for each calendar year must be paid in cash by January 30 of the following year. The Government sets prescribed interest rates every 3 months. Interest rates are increasing in Canada, and the prescribed rate will increase for the next quarter of 2022.
If you require assistance determining if this or any other type of tax planning strategy could benefit you, please get in touch with us.