# Taxation and high income



## axelis (Jan 13, 2015)

I’m doing some thinking over a specific situation and want to know if my thoughts and assumptions are on the right track, and if I’m not what am I thinking wrong… So let’s say you have a couple and one works and earns decent money (income taxed in the top bracket) and the other one does not work / has no income. The one who brings money in wants to invest, but outside of registered accounts. Now what would be a good investment vehicle for that person?

If the person chooses to invest in stocks, if they get paid dividends they will be heavily taxed because of the tax bracket. Also if they need to sell stock that performed well, they will also be highly taxed on the potential capital gain (not as bad as the dividends, but still). If they get paid interest from a savings account or other income producing investment, they will also be very heavily taxed (on 100% of the interest, the worst case of all 3). It would be pretty much the same story whatever else they invest in I’m guessing… are there any better options for the couple to reduce the amount of taxes they pay, or that's just the way it works?


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## pwm (Jan 19, 2012)

Two things come to mind:
1). Lend money to the non-working spouse to invest in his/her name at the govt. prescribed rate. 
2). Use a spousal RRSP. The withdrawal income will be taxed on the non-working spouses tax return.


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## AltaRed (Jun 8, 2009)

axelis said:


> ..are there any better options for the couple to reduce the amount of taxes they pay, or that's just the way it works?


On the surface, that is just the way it works. There are ways to provide your spouse with a spousal loan at the CRA prescribed rate of interest (takes paperwork) so the spouse then uses that loan to invest and make investment income (the spouse would have to pay you interest on the loan which is taxable to you). Also, you could form a CCPC and hire your spouse at an appropriate income to work in your company but again that takes some legal paperwork to put into place and it would have ongoing operating costs. I would think this topic is probably already covered in CMF.


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## axelis (Jan 13, 2015)

For #1, it's still at 1% this Q, isn't it?


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## birdman (Feb 12, 2013)

Assuming you either own or have good equity in your home you could talk to a professional and see if you could buy out your spouses 50% interest by way of an agreement. By doing this you she would get the cash and have to pay tax on the income and you would own the house. I understand there is no registered transfer of ownership on the certificate of title and the transfer is just for tax reason and covered off in the agreement. For Land Titles purposes the property is still registered jointly.


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## Confused (Jan 17, 2015)

AltaRed said:


> On the surface, that is just the way it works. There are ways to provide your spouse with a spousal loan at the CRA prescribed rate of interest (takes paperwork) so the spouse then uses that loan to invest and make investment income (the spouse would have to pay you interest on the loan which is taxable to you). Also, you could form a CCPC and hire your spouse at an appropriate income to work in your company but again that takes some legal paperwork to put into place and it would have ongoing operating costs. I would think this topic is probably already covered in CMF.


Call me stupid but I have no idea what a CCPC or CMF is.


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## AltaRed (Jun 8, 2009)

Canadian Controlled Private Corporate (CCPC) CMF--> Canadian Money Forum


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## axelis (Jan 13, 2015)

AltaRed said:


> you could form a CCPC and hire your spouse at an appropriate income to work in your company


That definitely looks like a lot of paperwork, and effort (just to setup the CCPC)... I was not aware of this option though, interesting. I guess there are always solutions if you're willing to be creative


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## NorthernRaven (Aug 4, 2010)

axelis said:


> The one who brings money in wants to invest, but *outside of registered accounts*. Now what would be a good investment vehicle for that person?


Is this because the person's RRSP room is exhausted (or somehow undesirable)? If not, one can contribute to a spousal RRSP, but the contribution reduces the _contributor's_ room, not the recipient's.


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## WiseOwl (Jan 1, 2015)

As someone above mentioned, the simplest method of achieving this would be to set up (with proper documentation) a loan to your spouse. Your spouse could then use the money to invest. At a minimum, the loan needs to bear interest using CRA's prescribed rate of interest. This rate will be in effect for the entire term of the loan (i.e., it does not need to change, even if CRA's prescribed rate of interest increases at some point in the future).

Your spouse must then pay the interest that accrues on the loan to you within 30 days after the calendar year end (i.e., January 30th). If your spouse doesn't pay the interest, the attribution rules will kick in and you will be taxed on any income/capital gains earned on the investments under sections 74.1 through 74.5 of the Income Tax Act.

Someone suggested setting up a corporation to hold your investments. I would not generally recommend this because investment income earned in a corporation is not subject to the small business rate. Instead, it's taxed at a much higher rate. Add costs associated to maintaining the corporation and this idea generally doesn't make much financial sense. 

Setting up a corporation to hold investments is generally more advantageous if you have an operating company that is earning significant cash and you want to dividend the cash out to a holding corporation that then invests the cash and earns investment income. This helps to keep your operating company "pure" for purposes of the lifetime capital gains exemption that is available on "Qualified Small Business Corporation Shares" and you aren't taxed personally until you pay a dividend out of your holding corporation.

An idea that hasn't been mentioned, and may often be overlooked because it is still a relatively "new" and not fully understood by many Canadians is the TFSA. Attribution rules do not apply to a TFSA, so you can "gift" money to your spouse who then purchases investments inside the TFSA. Any income or gains earned inside a TFSA that is derived from your "gift" of money to your spouse will not attribute back to you. This would also be a solution if you had kids that are over the age of 18 and wanted to gift them money that they would then invest (as the legal age to open a TFSA is 18).


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## HaroldCrump (Jun 10, 2009)

Do you have a mortgage?
If so, paying the mortgage down aggressively will provide the best risk-adjusted return bang for you, relative to schemes like spousal loans or incorporating yourself as a business.

IMHO, for someone with a mortgage and average investing skills, leveraged investing (HELOCs, spousal loans, etc.) is not as profitable.
You'd have to beat the market by several % points on an after-tax basis in order to justify the risk.


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## axelis (Jan 13, 2015)

NorthernRaven said:


> Is this because the person's RRSP room is exhausted (or somehow undesirable)? If not, one can contribute to a spousal RRSP, but the contribution reduces the _contributor's_ room, not the recipient's.


Yes the situation was assuming all basic options were already covered (RRSP maxed out, spousal contribution already performed...), and trying to gather more creative approaches to reduce tax on investments.


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## axelis (Jan 13, 2015)

HaroldCrump said:


> Do you have a mortgage?
> If so, paying the mortgage down aggressively will provide the best risk-adjusted return bang for you, relative to schemes like spousal loans or incorporating yourself as a business.


Indeed, the situation was assuming no debt and extra money to invest outside of registered accounts. But if there was any debt left I agree that reducing it would be a great risk-free option (and no need for any kind of research or paperwork, i.e. low effort).



HaroldCrump said:


> IMHO, for someone with a mortgage and average investing skills, leveraged investing (HELOCs, spousal loans, etc.) is not as profitable.
> You'd have to beat the market by several % points on an after-tax basis in order to justify the risk.


In the case of the spousal loan, considering the prescribed rate still sits at 1%, the risk would be very low, wouldn't it? Even more so if the loan recipient does not get taxed at all on the income generated by the loan. If the high income individual was to invest in almost any product (even a high ISA), assuming the no/low income individual could also invest in that same product, wouldn't the risk be worth it?

If I try to do the math, here is what I'm getting (let me know if my logic is flawed somewhere):

Invested amount = $20,000
Invested at low 1.5%
Tax rate 40%

Option 1, no loan:
income = $300
tax = $120
Net = $180

Option 2, spousal loan at 1%:

* Taxed individual 
loan interest income received by taxed individual / paid by recipient = $200
tax on loan income = $80
net taxed individual = $120

* Non taxed spouse
income earned on loan = $300
interest paid on loan = $200
net non taxed spouse = $100

Net couple = $220


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## joncnca (Jul 12, 2009)

maybe someone can clarify some points for me here:

1. Contributing to a spousal RRSP reduces the contributor's net income, and it reduces the contributor's RRSP contribution room. But they could just the same contribute to their own RRSP to reduce the contributor's net income. Whether you contribute to your own or your spousal RRSP, it makes no difference in how it reduces your net income because either way it would reduce the contributor's contribution room. So contributing to a spousal RRSP is not a specific way to reduce a family's taxes. The purpose of a spousal RRSP is only to provide that money to the spouse, in the spouse's name. The tax benefit of contributing to a spousal RRSP is the same as contributing to one's own RRSP. Right?

2. How does a spousal loan actually reduce the higher earner's net or taxable income? Charging interest is simply to avoid attribution rules. But how does giving the loan result in lower taxes owed for yourself/or for your family. Does this spousal loan only work, if the alternative is to invest the money yourself and get taxed at your own (high) tax rate? That means this spousal loan "scheme" will only reduce the taxes owed on *some kind of investment you make, *because these taxes are "shifted" to your spouse, who pays a lower tax rate. But it won't actually reduce the amount of taxes you owe as a result of your, for example, employment income...right?


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## Guban (Jul 5, 2011)

axelis said:


> Indeed, the situation was assuming no debt and extra money to invest outside of registered accounts. But if there was any debt left I agree that reducing it would be a great risk-free option (and no need for any kind of research or paperwork, i.e. low effort).
> 
> 
> In the case of the spousal loan, considering the prescribed rate still sits at 1%, the risk would be very low, wouldn't it? Even more so if the loan recipient does not get taxed at all on the income generated by the loan. If the high income individual was to invest in almost any product (even a high ISA), assuming the no/low income individual could also invest in that same product, wouldn't the risk be worth it?
> ...


The situation changes if you include the loss of the spousal credit. For each dollar the non taxed spouse earns, the taxed spouse loses a federal credit of 15% plus the corresponding provincial credit. In Ontario, the total loss is worth about 20%, so the $300 earned by the lower income spouse "costs" the higher one $60 in credit loss. This tilts the result away from a sure thing by investing in a HISA.


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## OptsyEagle (Nov 29, 2009)

Guban said:


> The situation changes if you include the loss of the spousal credit. For each dollar the non taxed spouse earns, the taxed spouse loses a federal credit of 15% plus the corresponding provincial credit. In Ontario, the total loss is worth about 20%, so the $300 earned by the lower income spouse "costs" the higher one $60 in credit loss. This tilts the result away from a sure thing by investing in a HISA.


You would be surprised how many so called "professionals" miss that very point that you just posted.


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## axelis (Jan 13, 2015)

Guban said:


> The situation changes if you include the loss of the spousal credit. For each dollar the non taxed spouse earns, the taxed spouse loses a federal credit of 15% plus the corresponding provincial credit. In Ontario, the total loss is worth about 20%, so the $300 earned by the lower income spouse "costs" the higher one $60 in credit loss. This tilts the result away from a sure thing by investing in a HISA.


So my attempt at doing the math above was indeed incorrect... thanks for pointing this out! Adding this would then impact the rate at which the spousal loan become an efficient option... too close to the prescribed rate and you're still not any better...

Let me try again with sightly higher rate like 2.5%, and taking into account the loss of federal credit:

Invested amount = $20,000
Invested at low 2.5%
Tax rate 40%

Option 1, no loan:
income = $500
tax = ($200)
Net = $300

Option 2, spousal loan at 1%:

* Taxed individual
loan interest income received by taxed individual / paid by loan recipient = $200
tax on loan income = ($80)
loss of spousal credit =($100) ~20% of the income earned by low income spouse below
net taxed individual = $20

* Non taxed spouse
income earned on loan = $500
interest paid on loan = ($200)
net non taxed spouse = $300

Net couple = $320

Is this still too simplistic, and have I missed anything else? I'm sure there is a way to model this properly, taking into account the maximum amount of spousal credit the high income individual could lose (any idea what that would be?) and also the fact that over a certain income, the low income will start getting taxed as well (although still at a lower rate)...


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## Eclectic12 (Oct 20, 2010)

WiseOwl said:


> ... Any income or gains earned inside a TFSA that is derived from your "gift" of money to your spouse will not attribute back to you. This would also be a solution if you had kids that are over the age of 18 and wanted to gift them money that they would then invest (as the legal age to open a TFSA is 18).


All good info ... though I would add the cavaet for the "legal age to open a TFSA is 18" depends on one's province/territory. 

CRA's web site points out:


> In certain provinces and territories, the legal age (depends on the age of majority) at which an individual can enter into a contract (which includes opening a TFSA) is 19 years old. Beginning in 2009, individuals turning 18 years old in these jurisdictions who would otherwise be eligible, will accumulate TFSA contribution room for that year, and will carry it over to the following year.


http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/lgbl-eng.html

The TFSA contribution room will be granted at 18 but won't be able to be used until age 19.


Cheers


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## pwm (Jan 19, 2012)

joncnca, you are correct. Neither of those strategies does anything to reduce current taxes. They are only a long term plan for future tax savings.


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## pwm (Jan 19, 2012)

As for spousal RRSPs: My wife did not work after we had our children. I contributed to both my own and a spousal RRSP. Now that I am retired and am drawing down our RIFs I see that there is one thing I would have done differently if I could turn back the clock. My marginal tax rate is about the same as when I worked, while hers is obviously far lower. With income splitting, half my RIF payment can go to her tax return, but 100% of her spousal RIF can go on hers. I have to pay about 44% tax on 50% of my RIF payment, while the other 50% is taxed at about 25% in her name. So as it stands, I can withdraw 75% of the total registered money in her name.* If I had contributed all of my RRSP money to her spousal account, then all the income would be in her name, and I would be better off now.* I had no way of anticipating the income splitting changes, but spousal RRSPs can still be a good thing, even with income splitting when one spouse does not work.

PS. Don't try to tell my wife that she didn't work while raising two children and several foster children.


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## Eclectic12 (Oct 20, 2010)

joncnca said:


> maybe someone can clarify some points for me here:
> 
> ... contributing to a spousal RRSP is not a specific way to reduce a family's taxes. The purpose of a spousal RRSP is only to provide that money to the spouse, in the spouse's name. The tax benefit of contributing to a spousal RRSP is the same as contributing to one's own RRSP. Right?


Viewed at today's rates ... there is no difference as either one results in the same reduction of income/taxes owing.

However, my dad was near the top and my mom was near the bottom in the years she did make money ... so I would think that deferring a top tax rate to withdrawn at or just above the bottom tax rate is going to work out so that the overall tax paid is less.

Don't forget that as my mom's top earning years were the early days of marriage *before* CPP - there wasn't going to be much of an income to worry about increased rates in retirement. Then too, the survivor benefit of his pension also reduced his pension income and the worries about CPP + pension + investments result in OAS clawbacks.




joncnca said:


> 2. How does a spousal loan actually reduce the higher earner's net or taxable income? Charging interest is simply to avoid attribution rules. But how does giving the loan result in lower taxes owed for yourself/or for your family. Does this spousal loan only work, if the alternative is to invest the money yourself and get taxed at your own (high) tax rate? ...


It increases the higher earner's taxable income by the loan interest (maybe the interest can be written off for a net zero effect?).

Where the spouse's tax rate is significantly lower, the taxable income from the investment is going to reduced. Going back to my mom, at today's Ontario tax rates, she would end up with eligible dividends resulting in a refund versus at my dad's rate - there would taxes owing.


Cheers


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## axelis (Jan 13, 2015)

pwm said:


> Neither of those strategies does anything to reduce current taxes


What if the spousal loan money is invested in income producing at a return rate higher than the prescribed rate? Wouldn't you be better of tax-wise? Or what my second attempt at doing the math also incorrect?


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## axelis (Jan 13, 2015)

pwm said:


> If I had contributed all of my RRSP money to her spousal account, then all the income would be in her name, and I would be better off now.


So basically when you retire you don't want necessarily both RRSP to be at equal value if one of the spouses has significant other (non registered) investment that produce income? Is that what's happening in your case (just making sure I understand), where you still have a high tax rate because of other income sources? 

In that case, would the ideal situation to be in, at retirement, something like spouse A (income from non-registered investments + RIF "forced" withdrawal) about the same value as spouse B (income from investments, if any, + RIF "forced" withdrawal)? So that both spouse income at retirement end up being about the same, hence taxed at about the same rate?


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## axelis (Jan 13, 2015)

Eclectic12 said:


> maybe the interest can be written off for a net zero effect?


You mean written off by the loan-receiving spouse? I.e. considered borrowing money (the loan) to invest ? Or written off by the spouse receiving the loan interest (not sure how)?


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## pwm (Jan 19, 2012)

The object is to have as close to equal income as possible, so as to pay the least tax.


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## AltaRed (Jun 8, 2009)

pwm said:


> The object is to have as close to equal income as possible, so as to pay the least tax.


Or at least to be in the same marginal tax bracket. There is a lot of space in the middle income bracket to end up being 'equal' on tax rates (the breadth of this band is large and clear on a federal basis, but will vary a lot on a provincial basis).

In BC for example, anyone with a taxable income between $37,606.01 to $75,213 is in the same bracket. Don't have to be more equal than that.


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## fraser (May 15, 2010)

As others have mentioned, the goal should be that both spouses end up in the same tax bracket. 

The only option that we were able to use was the spousal loan. It has saved us a good deal of tax over the past few years. We will be backing this off now that I am retired. Last year I claimed one percent interest income. My spouse took some 17 percent returns into her income and deducted her 1 percent interest expense. These loans have to be, or should be documented demand loans complete with witness signature. You never know when CRA will come knocking. Also, the loan interest must be paid by a Jan. 15 of the following year. We do account transfers and keep those records along with the loan paperwork. Works like a charm. 

CRA sets the prescribed interest rate every quarter. Once the loan is made the prevailing interest rate at the time the loan was made is the interest rate for the life of the loan. It is best to lock in early. If the prescribed interest rate were to dip, we would re do the loan paperwork to reflect that lower rate.


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## axelis (Jan 13, 2015)

fraser said:


> the prevailing interest rate at the time the loan was made is the interest rate for the life of the loan


Do you know if you can setup the loan and do all the paperwork with a certain loan amount (say $1k) and then over the years, increase the loan value while keeping the "locked" rate (at 1% as of the last 3 or 4 Q)?


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## Spong3 (Jan 29, 2015)

Guban said:


> The situation changes if you include the loss of the spousal credit. For each dollar the non taxed spouse earns, the taxed spouse loses a federal credit of 15% plus the corresponding provincial credit. In Ontario, the total loss is worth about 20%, so the $300 earned by the lower income spouse "costs" the higher one $60 in credit loss. This tilts the result away from a sure thing by investing in a HISA.


Sorry new here, just looking for a place to start learning about the most lucrative tax saving structure/opportunities. I followed everything up until this point. What do you mean by the loss of the 15% federal spousal credit? is this the 11,138 (2014) spousal amount??


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## Guban (Jul 5, 2011)

axelis said:


> Do you know if you can setup the loan and do all the paperwork with a certain loan amount (say $1k) and then over the years, increase the loan value while keeping the "locked" rate (at 1% as of the last 3 or 4 Q)?


Yes.


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## Guban (Jul 5, 2011)

Spong3 said:


> Sorry new here, just looking for a place to start learning about the most lucrative tax saving structure/opportunities. I followed everything up until this point. What do you mean by the loss of the 15% federal spousal credit? is this the 11,138 (2014) spousal amount??


In the situation where one spouse is working (spouse A), and the other is not (spouse B), the working spouse claims a spousal credit. If spouse B gets a job, that income is subtracted from the spousal amount that spouse A claims. Therefore, federally at least, there is no income tax advantage for the first $11,000 ish earned. Not that the corresponding provincial amount may not quite align. For example, in Ontario, spouse B can make a bit, but not reduce the provincial spousal amount.

See:
http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns300-350/303/menu-eng.html
http://www.cra-arc.gc.ca/E/pbg/tf/5006-c/5006-c-14e.pdf


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## axelis (Jan 13, 2015)

Guban said:


> Yes.


Would you have a source handy I can refer to by any chance (I know it's probably a long shot)? I did some research a while back and couldn't find the answer...


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## Guban (Jul 5, 2011)

axelis said:


> Would you have a source handy I can refer to by any chance (I know it's probably a long shot)? I did some research a while back and couldn't find the answer...


I've read it from a number if sources. Here's one
http://www.thebluntbeancounter.com/2011/07/1-prescribed-interest-rate-loan-great.html


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