Author Topic: Lending capital to your spouse for income splitting  (Read 5089 times)

scottish

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Lending capital to your spouse for income splitting
« on: November 24, 2019, 05:38:41 PM »
Is anyone doing this?     I've been studying the different scenarios to see where this could be to our advantage, and I think I've found one.

I'm wondering if there's a standard set of documentation to use regarding the size of the loan, the agreed (i.e. CRA proscribed)interest rate, when interest payments are made and so on.

SwordGuy

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Re: Lending capital to your spouse for income splitting
« Reply #1 on: November 24, 2019, 07:08:25 PM »
In the US, a loan isn't considered "income" because it has to be paid back.   

So if I give someone a loan from my income, I'm still on the hook for taxes on the full amount.  Is it different in Canada??


If the loan is forgiven in some manner, then the amount that was forgiven is considered their income and taxed.    The person who isn't getting their money back has a loss that can be used to offset taxes on other income.

Metalcat

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Re: Lending capital to your spouse for income splitting
« Reply #2 on: November 25, 2019, 06:09:01 AM »
I don't understand.

You want to loan your spouse money to lower your taxable income?

That doesn't make sense...

scottish

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Re: Lending capital to your spouse for income splitting
« Reply #3 on: November 25, 2019, 03:35:04 PM »
I can loan DW capital.   Income she makes from the capital is taxed in her hands.

She has to pay me interest on the loan at a rate proscribed by the CRA.   The interest is taxed in my hands.

In our scenario, DW stopped working when DD and DS were born 20 years ago and never started again.    We've been splitting our investments using TFSAs and spousal RSPs.    However, I have enough income to have built up a substantial non-registered portfolio as well.     I pay mucho tax on any investment income in the non-registered portfolio because of my high marginal tax rate.

This is a convoluted form of income splitting that avoids attribution rules in Canada.  (which probably means that annoying Morneau guy will try and eliminate it)    I should have explained in more detail in my first post, but I thought the method was well known.

Metalcat

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Re: Lending capital to your spouse for income splitting
« Reply #4 on: November 25, 2019, 03:52:25 PM »
I can loan DW capital.   Income she makes from the capital is taxed in her hands.

She has to pay me interest on the loan at a rate proscribed by the CRA.   The interest is taxed in my hands.

In our scenario, DW stopped working when DD and DS were born 20 years ago and never started again.    We've been splitting our investments using TFSAs and spousal RSPs.    However, I have enough income to have built up a substantial non-registered portfolio as well.     I pay mucho tax on any investment income in the non-registered portfolio because of my high marginal tax rate.

This is a convoluted form of income splitting that avoids attribution rules in Canada.  (which probably means that annoying Morneau guy will try and eliminate it)    I should have explained in more detail in my first post, but I thought the method was well known.

lol, yeah, that wasn't at all clear from your initial post.
You tend to know your stuff though, which is why I was so confused by what it sounded like you were asking.

I think you hit the nail on the head though, I think the risk is in potential policy changes that could work against you. As someone who works in finance with medical professionals, I saw a lot of incorporated professionals lose their shit over the recent policy changes.

Just how large a margin are you looking at in terms of benefit here?

Mighty Eyebrows

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Re: Lending capital to your spouse for income splitting
« Reply #5 on: November 25, 2019, 10:48:33 PM »
Scottish, it sounds like you know what you are doing. I am not an expert, but my understanding is that you just need to be very careful about documentation and actually make proper interest payments in a way that you can point at for CRA. January 30th is an important payment date for interest. I have not heard of a limit on the size of loan and I have not found a "standard" set of documents.

https://www.taxtips.ca/personaltax/lend-to-spouse-child.htm
https://www.financialwisdomforum.org/forum/viewtopic.php?f=32&t=114368

It looks like you are already using a Spousal RRSP. You probably also know that you can give her money to put in her TFSA, as long as she doesn't remove it and put it in a taxable income-generating investment.

https://www.finiki.org/wiki/Income_splitting

Malkynn, the prescribed interest rate is currently 2%, but was down to 1% for a while. The return on a balanced portfolio is usually high enough that it a decent way to move some income to the lower-taxed person. What the Federal Liberals do next for taxes is anyone's guess. I am worried about the Capital Gains inclusion rate, but more because of a business property we are trying to sell.

https://www.canada.ca/en/revenue-agency/services/tax/prescribed-interest-rates.html

(Edit: Minor correction)
« Last Edit: August 29, 2020, 11:53:23 AM by Mighty Eyebrows »

scottish

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Re: Lending capital to your spouse for income splitting
« Reply #6 on: November 26, 2019, 07:37:45 PM »
^*&^@# it!   I missed the 1% loan rate!

Both our TFSAs and RSPs are maxed out.   That one was so obvious I couldn't miss it.

The "loaning your spouse money to invest" thing is quite a bit more complicated.     If I'm happy with the numbers, I'll probably have to get advice from an accountant who specializes in this stuff.     There are a lot of factors that are hard to predict here - rate of return on the investments, changes in tax policy, when I FIRE,  how long we live...   so I'm trying to be thorough before I commit to anything.

Metalcat

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Re: Lending capital to your spouse for income splitting
« Reply #7 on: November 26, 2019, 07:46:48 PM »
^*&^@# it!   I missed the 1% loan rate!

Both our TFSAs and RSPs are maxed out.   That one was so obvious I couldn't miss it.

The "loaning your spouse money to invest" thing is quite a bit more complicated.     If I'm happy with the numbers, I'll probably have to get advice from an accountant who specializes in this stuff.     There are a lot of factors that are hard to predict here - rate of return on the investments, changes in tax policy, when I FIRE,  how long we live...   so I'm trying to be thorough before I commit to anything.

Let me know if you need a referral for someone who can handle this kind of thing in Ottawa, it's the type of move that can easily go sideways with bad advice.

Missy B

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Re: Lending capital to your spouse for income splitting
« Reply #8 on: December 10, 2019, 08:51:23 AM »
For those of us who had no clue what the OP was talking about (it's a little dated, interest rate is now 2% as previously noted):

https://turbotax.intuit.ca/tips/one-way-to-split-income-with-your-spouse-a-spousal-loan-2391

Goldielocks

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Re: Lending capital to your spouse for income splitting
« Reply #9 on: August 26, 2020, 12:54:47 AM »
Prescribed rates should be back to 1% now.

The rate at the loan origination date remains fixed for the duration of the loan... it won't go up and doesn't need to be paid back until the end of the loan. 

https://www.advisor.ca/tax/tax-news/prescribed-rate-scheduled-to-drop-for-q3/

This is one of the older and more stable tax "rules" and I would guess unlikely to change.   It is actually a rule to get people to pay more tax, (than before) so it doesn't make sense that it would go away.   

You do need a sizable non-registered portfolio, or a real estate portfolio, and an income differential between you and your spouse to make it work.

If you want to be extra clear, get the loan notarized (basic information on a piece of paper), and have the interest payments made regularly and traceable.  Perhaps once a year annual interest payments by bank transfer or something should work well.

Let us know what you ended up doing!

scottish

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Re: Lending capital to your spouse for income splitting
« Reply #10 on: August 29, 2020, 09:38:29 AM »
Ok, I've worked this out for our current asset allocation.   On a hypothetical $1000 investment, I would
pay $11.12 in taxes and DW would pay $0.40 in taxes.

ETFIncomeDividendsCapital gainsInvestment amountIncomeDividendsCapital gains
ZAG1.25% 0 0 $250 $3.13 0 0
XEF2.40% 0 0.1% $250 $6.00 0 $0.25
VFV1.47% 0 0 $250 $3.68 0 0
XIC0.54% 2.86% 0.81% $250 $1.35 $7.15$2.03
Totals$1000$14.15 $7.15$2.28
Tax owing Scottish$7.64 $2.86$0.61
Tax owing DW$0.83-$0.49$0.06

However, DW would have to pay me $10 in interest on the loan.  I would pay $5.40 in taxes on this interest, but the $10 would be deducted from her income, reducing her taxes to maybe $0.20.

So it sounds like an annual tax savings of about $11.12 - $0.20 - $5.40 = $5.52.

Equally important - as the investments grow in value, this growth is being transferred to DW.   If we were to assume an average return of 6% over 5 years*, and subtracting the 1% interest payment, this would transfer about $275 in capital.

This looks like a worthwhile exercise if you have sufficient funds.

Anyone see any obvious errors?

* yes I know, it's pretty well impossible to accurately predict investment gains over a time as short as 5 years.   I need to use something though.

** the tax calculations look a little sketchy because I'm considering an amount a bit larger than $1000, so they have to factor in personal deductions and stuff

Mighty Eyebrows

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Re: Lending capital to your spouse for income splitting
« Reply #11 on: August 29, 2020, 11:55:45 AM »
Perhaps once a year annual interest payments by bank transfer or something should work well.

Making the interest payment by January 30th for the preceding year is very important. Otherwise the loan instantly becomes tax-attributable back to the higher income spouse.

Goldielocks

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Re: Lending capital to your spouse for income splitting
« Reply #12 on: September 07, 2020, 12:12:26 AM »
Calc looks good, except --the final capital gains, when you eventually sell, you haven't included it yet, have you?

Only two funds have minor capital gains showing - these are distributions, right?  What about the final sale in a few years, that will be at your spouse's tax rate too...

Assume a conservative 3% capital gains on the $1000 overall, per year (assume you sell everything and buy comparable ETFs for the next year).  This is in addition to your dividends, etc, for a total return about 5% annually.

$30 Gains x (54% - 2%)  x 50%= $7.80 additional tax dollars saved.
Total savings: $7.80 + $5.52 = $13.32

Total rate of savings: 1.33%...  So, this is the same as getting another 2% return on your investments.

(Or did I miss where you already allowed for capital gains.?  You mentioned growing in spouse's name so maybe not yet included?)

The next two challenges

-- This is not worth it for $13/year, but if you had $100k to invest, then you get $1330/yr which is very attractive.

-- Did you factor in the very low dividend interest rate for your spouse?  It could be a negative tax rate on eligible dividends, so maybe you want to skew to CDN eligible dividends?  Your tax rate on these is 39%, and your spouse's could be as low as -6%.  (Guessing at your relative incomes / province here).

And finally
In your tax situation, you do have spousal RRSPs going on, right?   Contribute to a spousal RRSP to the max this year, and then stop adding to it for 3+ years, and your spouse can withdraw the money and pay at their income tax rate over a few years, then you repeat.  This is terrific for early retirees, or if you want to just convert from a higher to lower tax rate and have some time to plan it out.

scottish

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Re: Lending capital to your spouse for income splitting
« Reply #13 on: September 07, 2020, 08:18:58 PM »
Calc looks good, except --the final capital gains, when you eventually sell, you haven't included it yet, have you?

Only two funds have minor capital gains showing - these are distributions, right?  What about the final sale in a few years, that will be at your spouse's tax rate too...

Assume a conservative 3% capital gains on the $1000 overall, per year (assume you sell everything and buy comparable ETFs for the next year).  This is in addition to your dividends, etc, for a total return about 5% annually.

$30 Gains x (54% - 2%)  x 50%= $7.80 additional tax dollars saved.
Total savings: $7.80 + $5.52 = $13.32

Total rate of savings: 1.33%...  So, this is the same as getting another 2% return on your investments.

(Or did I miss where you already allowed for capital gains.?  You mentioned growing in spouse's name so maybe not yet included?)

The next two challenges

-- This is not worth it for $13/year, but if you had $100k to invest, then you get $1330/yr which is very attractive.

-- Did you factor in the very low dividend interest rate for your spouse?  It could be a negative tax rate on eligible dividends, so maybe you want to skew to CDN eligible dividends?  Your tax rate on these is 39%, and your spouse's could be as low as -6%.  (Guessing at your relative incomes / province here).

And finally
In your tax situation, you do have spousal RRSPs going on, right?   Contribute to a spousal RRSP to the max this year, and then stop adding to it for 3+ years, and your spouse can withdraw the money and pay at their income tax rate over a few years, then you repeat.  This is terrific for early retirees, or if you want to just convert from a higher to lower tax rate and have some time to plan it out.

For capital gains, the working assumption is that I will no longer be working when we start drawing on the assets from the portfolio.   So the tax rate should be the same whether DW reports the gains or I report the gains.

You're correct, only 2 of the funds were reporting capital distributions recently, and these were small.

I roughly factored in the -negative tax rate on dividends for DW.   I only counted dividends from  XIC for this, other dividends aren't eligible in Canada and count as income. I had to make some simplifications to deal with personal deductions.

I'm thinking about a six figure loan.   The biggest problem I'm running into is that all of my assets have substantial unrealized gains.    Selling them to loan cash to DW will trigger capital gains.*   I'm thinking maybe I should have loaned her 25K a year every year starting when we paid off the house.    Too late now!

I think  I mentioned that our registered accounts are all maxed out already...

* My accountant says I could lend her the assets directly, but then capital gains are attributed back to me.    So this seems to cancel out the benefit of transferring capital to DW.   Plus I would probably have to pay him to do our tax returns as things are starting to get complicated.