The Fund Library :: Columns :: Splitting income with inter-spousal loans

TAX PLANNING FROM THE KNOWLEDGE BUREAU

By Knowledge Bureau Staff

With the recently proposed tax reforms, more doors continue to close on opportunities for income-splitting between spouses. However, there is still one key strategy – the inter-spousal loan – that can minimize tax where one person in the couple earns significantly more than the other.

It’s a good idea to discuss this planning opportunity with your tax advisor well before year-end, while the CRA’s prescribed interest rate for inter-spousal loans is still at the very low level of 1%. Who knows how long this attractively low tax rate will remain in effect?

Under normal attribution rules, any money transferred from one spouse, typically the higher-income spouse, to another is deemed to be taxable in the hands of the transferor, at that person’s higher marginal tax rate. Income splitting opportunities are therefore thwarted.

However, inter-spousal loans are an important exception to this rule, as long as they are set up and adhered to correctly. With such a loan, any investment income earned from the money transferred to the lower-income spouse will be taxed at that person’s lower tax rate. This can lead to significant savings on the couple’s total tax bill.

Tax and financial advisors can calculate the tax advantages; setting up inter-spousal loans now at the 1% prescribed rate locks in the rate for the life of the loan. That’s important with the real possibility of more interest rate hikes in the offing for 2018.

What else do you need to know about interspousal loans?

* The loan must be documented properly in writing, for example, with a promissory note, including repayment terms.

* The lending spouse must charge the other spouse interest at least equal to CRA’s prescribed rate (currently 1%).

* The spouse receiving the loan must pay the interest owing to the lender every year (by January 30). Failure to meet this condition will result in the normal attribution rules kicking in, meaning that income earned from the lent money will be taxed in the hands of the higher-income spouse in that year and all future years.

* The lending spouse is required to report the interest received as income on his or her income tax return. Conversely, the borrowing spouse can deduct the interest paid on his or her tax return, as long as the loan was used to purchase income-producing assets with the potential of earning passive income, within in a non-registered account.

* The spouse receiving the loan is required to pay back only the interest due; there is no requirement to repay the principal.

Planning to split family income is an important part of year-end that planning. See a qualified tax advisor, such as a DFA-Tax Services Specialist, for help in setting up inter-spousal loans.

This article originally appeared in the Knowledge Bureau Report, © 2017 The Knowledge Bureau, Inc. Reprinted with permission. All rights reserved. Follow Evelyn Jacks on Twitter @EvelynJacks. Visit her blog at www.evelynjacks.com.

Evelyn Jacks’ latest book, Family Tax Essentials, is now available.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.