Terry Tang, Investment Advisor
November 20, 2020
Recently, I have come across many videos on YouTube about splitting assets between family members to reduce taxes without ever mentioning income attribution rules. Bad tax tips can negatively impact a family’s finance and that is why viewers need to make sure that they are getting the right information from a qualified professional.
how does income splitting work?
Generally, an income-splitting strategy involves allocating assets from a high tax bracket individual to his/her spouse or children with a lower tax bracket. The goal, obviously, is to reduce taxes payable in the family. However, aside from the use of spousal RRSPs and the splitting of eligible pension incomes, attribution rules are in place to prevent families from achieving just that. Here’s how it works.
"The attribution rules stipulate that certain types of income be taxed in the hands of the giver and not the recipient, even though the assets are in the hands of the recipient."
The attribution rules stipulate that certain types of income be taxed in the hands of the giver and not the recipient, even though the assets are in the hands of the recipient. If assets are transferred from an individual to the spouse in the form of a gift, all investment income and capital gains would be “attributed” back to the giver. In other words, it would still be taxed in the hands of the giver, and not the spouse, so that no tax benefits would have resulted. Shifting assets between spouses is not a viable tax reduction strategy.
transferring assets to minor
On the other hand, if assets were transferred to a child, capital gains are not subject to income attribution. This rule, however, has been under scrutiny and may be changed in the future. But until then, gifting assets to minor children with an emphasis on capital gains can be an effective tax reduction strategy.
the use of joint accounts
Married couples using joint accounts is a good way to invest for a number of reasons, including from the perspective of estate planning, which will be discussed in another day. However, the spouses need to be mindful of the original contribution ratio, that is the proportion of the assets each of the spouses has contributed. This is important because the contribution ratio is used to determine how investment income is allocated and taxed.
For example, if the husband contributed 40% and the wife contributed 60% of the assets into the joint account, all investment income would be allocated and taxed according to the 40/60 ratio. This ratio cannot be changed unless affected by new contributions or withdrawals. If a spouse transferred assets from an individual account to a joint account, these assets are subject to attribution rules and future investment income is “attributed” back to the original spouse.