Determining Income Sources That Can Be Split

In the past few years, governments have been moving towards family income splitting in very limited circumstances. For example, in 2007 it became possible for those who receive certain pension benefits to transfer up to 50% of that income to a spouse if that is to their tax advantage. This will usually provide for tax savings as pensioners take advantage of the progressivity of tax brackets and rates.

It is also possible for business owners to split the revenues they earn by hiring their spouse or children in the business, if they otherwise would have hired a stranger to perform the role. The family member must be qualified to perform the role and actually do so, for reasonable compensation similar to what would be paid to a stranger. In this case, the amounts paid are deductible to the business owner and taxable in the hands of the family member.

This is great tax planning, as it opens up tax advantaged investment opportunities for the family members by creating "roomî for contributions to Registered Retirement Savings Plans (RRSP) and in the case of adults, contributions to the Canada Pension Plan (CPP), and Tax-Free Savings Account (TFSA).

Certain employed commission sales agents may also split income by hiring a family member as an assistant, however the fact that this ­assistance is required and paid for by the agent must be a condition of their contract of employment.

When it comes to splitting investment income the rules are more ­complicated, as described below. Passive income from investments is reported each calendar year and, with the exception of rental income, will not create RRSP contribution room. The primary categories of investment income are:

ï Interest: this income is reported in full in the year received, or in the case of compounding investments, in the year accrued.

ï Dividends from Canadian Corporations: Paid out after-tax profits of a corporation, the actual amounts received are "grossed upî on the tax return, thereby increasing a taxpayer's net income. You'll see this on your T-slip as the "taxableî amount. This gross-up can have an effect on the size of refundable or non-refundable tax credits. However, the dividend is offset by a dividend tax credit which reduces federal taxes and, in the end, gives most investors better tax results than interest earnings. Dividends from Canadian Controlled Private Corporations are subject to different gross-up and dividend tax credit rates from those of public corporations, because of the way the corporations are taxed. This system ­integrates the personal and corporate tax systems in an attempt to avoid double taxation.

ï Rents: This income is reported on a "net profit basisî and is ­generally nil, as many taxpayers like to reduce their rental income by claiming a deduction called Capital Cost Allowance based on the value of their building. This may however cause a tax problem in the future, if buildings appreciate over time.

ï Royalties: This income is reported in full, but certain resource properties may be subject to more advantageous tax treatment.

It is important to understand how you might earn these types of income from your investments. If you are still unclear about these terms speak to your advisors so that you can match investment products to income sources.