Don’t Drink From The Firehose. Plan Your Income Sprinkler.

The main objective of income splitting is to evenly distribute the income between a higher and lower taxed spouse to minimize your household tax bill. Canadian Controlled Private Corporations (CCPCs), or professional corporations, have allowed adult children and parents of the owner to also be non-voting shareholders. That allowed high-income professionals to split their income using dividends amongst multiple family members. As described in my background post about income splitting, that has ended.

Income Sprinkling

CCPC Tax changes

The term “income sprinkling”, as popularized by Wild Bill’s Fair Share World Fair, was probably meant to be inflammatory. However, there is some accuracy to it.

If all income in a high-income household flows to one or two people, like a high-pressure hose, much is lost to taxes. Spreading the income out in smaller amounts to multiple family members keeps marginal tax rates as low as possible. Like a sprinkler.

The new dividend rules penalizing dividends turn down the water pressure. You can’t move as large amounts of income as quickly and easily., However, it does not stop it completely. We can still water our financial gardens without the firehose. But, we need to plan our irrigation system more carefully and be patient.

Different Income Sprinklers For Different Timeframes

We need to plan differently to meet income-split over different time horizons.

Short-term: Disperse money to be able to access it now while lowering this year’s tax bill.

Intermediate-Term: Build up income-generating assets for the lower income partner.

Long-term: Spread out where you access your retirement income from to decrease taxes during portfolio drawdown years.

Short-Term Income Splitting

The main short-term objective to try and have you and your spouse’s income as close to each other as possible. This is where the new CCPC dividend rules hurt the most. However, there are some tools available to help with this for those in moderately high income brackets:

How much income can you potentially redirect?

We will examine the details of these in my follow-up posts, but a high income self-employed professional may be able to redirect $25K to $50K towards their spouse this way without too much fuss depending on their practice type and revenue. It is not unlimited or free of excess effort, like with dividends, where we could hose money at our spouse under high pressure. However, there are some options.

Short-term income-splitting example.

Hiring a spouse for a market-rate salary.

For example, if you are a family doc who bills around $350K, netting $250K/yr after your basic office overhead, and your spouse makes $50K/yr at their own job. Neither you nor your spouse are probably interested in your spouse becoming your office secretary. Instead, you hire them to do some basic billing and management for your practice paying another $15K/yr. This is a low-hanging fruit and the more money involved in your practice, the higher you can probably justify paying them.

That would bring your taxable income down to $235K and your spouse’s up to $65K. That small shift drops your household tax bill from $105K to $101K. every year – it is something. Furthermore, that $15K is also money kept in your household instead of paid out to someone else.

If a spouse works >20h/wk for your business, you could income-split with dividends still.

If they did legitimately take on more that 20h/wk for your practice, then you could potentially still income-split using dividends. That would lower your corp/household tax bill to $94K. That is $11K/yr more money for your family. However, you must keep good records in case CRA wants you to prove their role. Payroll records and a well-kept work log makes sense as evidence, but the rules are still quite new and we haven’t seen how the are audited yet.

Using the Spousal RRSP for short-term income splitting.

If you use spousal RRSPs as an income splitting technique then you further drop your taxable income to $209K. The $26K/yr that you contribute to them via a spousal RRSP lowers your tax bill to $97K for those years. Since you are tying money up in an RRSP, that lowers your cashflow by 12K/yr.

After a 2-3 years lag of not making contributions, your spouse can take that money out taxed in their hands. If taken out before that lag, the income would be attributed back to the contributor. This limits the utility of spousal RRSPs for short-term income splitting, but it can be useful for intermediate-term goals like funding a parental leave or sabbatical where your spouses’ income from their outside job drops that year if you plan that far in advance. We fully delve into the uses of spousal RRSPs across the life cycle in a follow-up post.

The bigger the difference in you and your partner’s base income, the larger the potential benefit.

How much these approaches mitigate the tax bill also depends on you and your spouse’s incomes. The closer their income to zero and the higher your income is above $220K/yr, the harder you are hit in the short-term with the rule changes.

On the other end of the spectrum, there is also no point of income splitting once you have bumped their income up over $220K/yr if they are also a high earner since that would put them in the highest marginal tax bracket also.

Intermediate-Term Income Splitting

Developing an intermediate-term income splitting strategy revolves around having a lower-income spouse develop a portfolio of income producing assets. Building an income-machine attributed to them means passive income taxed at their lower rates.

Is developing an intermediate-term income splitting possible?

You need personal money to invest.

To develop passive income streams for a lower-income spouse, you need to have excess personal money to invest. That means that your household spends less than it makes. For building a lower-income spouses’ passive income to matter, you also need money left after taking advantage of your tax-sheltered accounts (TFSAs and RRSPs).

That comes from spending within your means consistently. However, you may also want to consider this if you get after-tax windfalls like an inheritance, gift, or proceeds from a major sale.

You also need to accept functioning as a financial unit.

That means accepting optimizing who pays and who builds the assets in their name as opposed to trying to evenly split costs and ownership. The reality is that if you split up, everything is shared whether you co-operated and shared or not. So, it is better to optimize and build a larger pot regardless. Plus, couples who pool their finances are more likely to be happy and stay together.

You need to be comfortable with the high-income earner paying for all living expenses and TFSA contributions from a joint account. That preserves the lower-income spouse’s money to invest without triggering the attribution rules.

Is developing an intermediate-term income splitting plan helpful?

Larger income difference, longer time horizon, and more disposable income = more useful.

If there is a large income difference and you are able to build a large personal account attributed to the lower-income spouse, then that progressively makes a larger difference as it grows. So, a larger income difference and a longer run-way makes it more important. The more after-tax money you have to invest, the bigger difference it makes.

Early Retirement

Whether you plan to retire early or want more flexibility in case life throws you a curve-ball before age 65, intermediate-term income splitting can help.

After the owner turns 65, a corporation can income split within spouses again. Similarly, RRSPs and pensions can be split over age 65. However, if you need to draw from your portfolio before that age. Having a pot for a low-income spouse to draw from at a lower tax-rate is great.

Big Splurges

You may intermittently have large cash outflows to pay for a splurge. Maybe a cottage or a big honkin’ motorhome to vacation in. Having a pot of after-tax money to draw from instead of pulling money out of your corporation and triggering taxes can be helpful. If the capital gains are taxed lightly in a low-incomes spouse’s hands.. Even better.

    What tools can we use for intermediate-term income splitting?

    Long-Term Income Splitting In Retirement

    This actually gets a bit easier – I suspect because people over 65 get out, vote, and make optically poor targets for politicians.

    You are able to split income from RRSPs/RRIFs, CPP, and even dividends from your CCPC as long as you are over age 65.

      It becomes easier to shift things around when you are over 65, but it is still probably be prudent to have your assets as evenly distributed as possible in the years leading up to this.

      That makes it easier if you decide to retire or semi-retire earlier than 65. Not only does that require a larger nest-egg and the boost intermediate-term strategies provide. The ability to draw income from both partner’s investments to minimize the tax becomes critical. You many not be planning to retire before 65, but you could change your mind for a variety of reasons or be forced to.

      This was a quick overview to set the scene. We will explore each of the strategies introduced in the upcoming posts.

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