Taxes are necessary to fund infrastructure and other essentials, but if you’re unprepared, paying a sizable tax bill will place a serious strain on your budget. Because of this, many families decide to use an income splitting strategy, when available, to reduce a household’s overall tax bracket.
In this article, we’ll cover the basics of income splitting for medical professionals and how our team can help.
Income splitting explained
In order for your income levels to be comparable for tax reasons, income splitting is the practice of having the higher-earning spouse shift a portion of their income to the lower-earning spouse. Ideally, you and your spouse or common-law partner will be in the same tax bracket annually.
4 ways to split income
- A spousal loan is a popular strategy that is typically advantageous when one spouse has much higher taxable income than the other. With this arrangement, the family member with the higher income can lend money to the spouse with the lower income at the prescribed rate set by the Canada Revenue Agency (currently 2%). The plan is to invest the borrowed funds in order to obtain a return that is higher than the required rate while also enabling the family to reduce their tax burden.
- TFSAs, or tax-free savings accounts, are yet another useful resource. According to the tax laws, a spouse with a higher income can give their partner money to put into their TFSA (you are unable to make direct contributions to your spouse’s TFSA.) Contributions to a TFSA are not tax deductible, but if the money is invested, it can grow tax-free, be withdrawn tax-free, and be transferred to a recipient tax-free. In contrast to spousal loans, where income is attributable back to the provider, investment income received in a TFSA is tax-free. This would be limited to the annual TFSA contribution limit of your spouse.
- You can pay your spouse and/or kids from your corporation for work they have performed for the corporation. There are tests set by CRA to determine the amount paid to a family member but it is generally advantageous to do so as it will reduce the amount you draw from the MPC as a salary/dividend which will reduce the tax burden for the family.
- You can start a family trust and invest personal assets in the trust to have the income distributed to the beneficiaries (family members). Similar to a spousal loan, you lend the capital to the trust at CRAs prescribed rate and the trust will invest the capital with the intent of generating income which will be paid out to your family members at their personal tax rates. Given that a beneficiary of a trust does not need to be 18 or work to earn the income there is flexibility in who you pay the income to and how much. There are rules around the type of income earned in a trust so you will need to be careful what investment are selected but this strategy will generate a tax savings for the family by directing income to pay for the kids expenses (private school, camps, trips, etc) that you don’t need to draw as a salary yourself.
There are numerous opportunities to gain from income splitting at various periods of life, and it continues to be a potent planning strategy for tax minimization. Don’t let taxes reduce the reward you receive for your labour. We recommend working with a financial advisor to get more details on how income splitting works as well as suggestions on how to lower your tax obligations.
Let’s get started preparing together by contacting one of our experts at Medtax.ca here!
