Spousal tax strategies, part 1
How to take full advantage of spouse’s lower tax rate
If your spouse earns less income than you or no income at all, then the desire to share everything you own with them may also include sharing your taxable income so that you can use up their graduated tax rates. However, all is not fair in love and taxes. Just because you are willing to share your wealth with your better half doesn’t mean the Canada Revenue Agency (CRA) will be quite as generous.
While a transfer of property between spouses qualifies for an automatic tax-deferred rollover, the income that might arise from such gifted property doesn’t benefit from the same treatment. The general rule is that any subsequent income arising from such transferred property will be attributed back to the transferor spouse. There are, however, exceptions to these general rules.
Making the most of independent capital
Where the lower-income spouse has independent capital, the earnings generated on such capital will generally be taxable to the lower-income spouse. So, a simple rule is to make sure that the lower-income spouse invests their capital, while the higher-income spouse’s earnings/capital is used for day-to-day living expenses. Examples of independent capital can include just about anything that doesn’t come from the higher-income spouse, e.g., a gift or inheritance from a parent, or earnings from a lower-income job.
You can maximize a spouse’s independent capital in a number of ways. For example, use the higher-income spouse for personal expenditures, and even paying the lower-income spouse’s taxes. Likewise, if a parent of one of the spouses is thinking of giving some money to the family, it’s better tax planning if the gift is made to the lower-bracket spouse.
Make sure that the lower-income spouse’s earnings and other independent capital are segmented in his or her own bank account and not commingled with money that comes from the higher-income spouse e.g., joint accounts and the like. That way, there should be no question about who pays the tax on the income. Make sure that these “pure” accounts continue to “track.” For example, if the money is invested in stocks, they should go into a separate “pure” brokerage account in the sole name of the lower income spouse.
The loan manoeuvre
You can avoid the attribution rules if the investment your spouse makes is funded by a loan from you as the higher-income spouse, provided that your spouse pays you interest at the “prescribed rate” in effect at the time the loan is made (currently 2%). Moreover, the interest on this loan has to be paid by no later than Jan. 30 each year. If you miss even one Jan. 30 deadline, the attribution rules will apply forevermore.
If you don’t have cash to lend to your spouse, consider doing a loan in kind. For example, if you have a securities portfolio in your name, transfer the portfolio to your spouse and have your spouse issue a demand promissory note reflecting the prescribed interest rate for an amount equal to the fair market value of the portfolio at the time of the transfer. However, as the transferor, you may be subject to capital gains tax because the transfer would have to be made at the portfolio’s fair market value (see further discussion below).
The swap rule
Special rules allow your spouse to pay tax on income or capital gains from an asset that you transfer, provided that your spouse “buys” it from you and pays for it with an asset having at least an equivalent value. Obviously, this technique works best if the spouse pays for the investment with personal-use (i.e., non-income-earning) assets that he or she personally owns.
A drawback is that to qualify for this break, you are subject to tax rules that treat you as if you sold the investment at its current market value so, you are potentially subject to capital gains treatment on any appreciation in value when you swap the investment. But if you have capital loss balances, you may be able to offset the capital gains exposure.
As an alternative, you may still be sitting on a number of stocks that are in a loss position, so you may consider swapping those stocks and triggering a loss. In many cases the swapped investments may not have appreciated in value in the first place, so there would be no capital gains exposure. This will usually be the case, for example, with bank accounts, GICs, and so on.
Watch out for rental or business real estate, though: Even if it hasn’t appreciated in value, previous years’ depreciation claims could be included in your income (“recaptured”) if you transfer real estate. Moreover, you could be triggering land transfer tax on transfers of real property (whether business or personal use).
Of course, one problem is that the spouse may not have assets to swap to begin with. In most families, something should be available. For example, an interest in a home held jointly could qualify, or perhaps a car.
Next time: Spousal tax planning: start-companies, income-splitting pensions and RRSPs
Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. Portions of this article first appeared in The TaxLetter, © 2019 by MPL Communications Ltd. Used with permission.
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The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.