Dollars and Sense: Splitting Income

By Sheila Nelson, CA

A new pension splitting measure was announced by Finance on October 31, 2006. This may allow taxpayers to split their pension income and shift it to the spouse with lower income. What exactly does this mean?

Under most circumstances, income splitting of any kind is generally prohibited under Canada’s tax laws. However, beginning in 2007, a taxpayer can begin splitting certain types of income with his or her spouse. If a taxpayer is 65 years of age or older, the types of income that can be split include:

• lifetime annuity payments under a registered pension plan
• a matured registered retirement savings plan
• a deferred profit sharing plan
• payments from a registered retirement income fund

For those taxpayers under the age of 65, pension income eligible for income splitting will include certain pension income payments received as a result of the death of the taxpayer’s spouse.

Why would you want to split income?

Our taxes are based on a graduated rate system. This means that we have several different tax brackets. For example, if you make $50,000 per year, you are considered to be in the "middle" tax bracket. The first approximately $36,000 is taxed at around 24%, with the remaining $14,000 taxed at 34%. The next 2 tax brackets are approximately 40% and 43.7% respectively (BC rates used).

Two people who each make $50,000 a year will pay combined taxes of just over $20,000 in 2006 in BC. Compare this to one individual who makes $100,000 per year (we’ll assume the spouse doesn’t work). That individual will pay taxes of $28,000 in 2006 in BC or $8,000 more in taxes! That is why income splitting can be so powerful!

If you can take advantage of this opportunity, it means you will need to analyze different income allocations to determine the optimal split. You should also be aware that you may be affecting such items as a potential for OAS (Old Age Security) clawback, transferability of spousal credits and possible elimination of some personal tax credits.

What do you need to do right now to income split? Essentially, nothing. You won’t need to make any allocation until you file your 2007 personal income tax returns by April 30, 2008. However, if this is an option and you are currently paying instalments, you may want to consider whether or not you can reduce your 2007 instalment payments. One word of caution: if you guess wrong and don’t remit enough, expect to pay instalment interest and penalties next year.

Sheila Nelson is a Chartered Accountant and partner  with Chan Foucher LeFebvre LLP

You can reach her at www.cflca.ca

or by email  sheilan@cflca.com

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