Income Splitting & Video Games:
Remember the arcade-style racing games from the 80s? Games like “Pole Position”, where you had to keep your car going as fast as possible without crossing the red and white shoulders and skidding onto the grass.
That’s income splitting. The car is your family’s tax burden, and the shoulders are you and your partner’s tax brackets. When one partner makes more money than the other, the tax brackets are different. Your goal is to keep your car as centered as possible.
Let’s keep this in Alberta and say that Spouse A makes $300,000 a year while Spouse B makes $50,000. In 2017, Spouse A’s personal taxes will be approximately $107,500 while Spouse B’s taxes will be approximately $8,000, bringing the family’s tax burden to $115,500. If, however, you shrink the income gap so you’re both making $175,000, your overall tax bill will be approximately $106,000. Same overall family income, but a $9,500 reduction in your family’s tax burden.
But how to keep the car in the centre of the road? The Liberal government has axed the 2014 “Family Tax Cut”, a benefit where families with wide income disparities could move up to $50,000 between them. Intrepid splitters, however, aren’t easily swayed.
No matter the government of the day, where there’s a creative will there’s always a way. Your first step is to talk to a tax planning professional who you trust. Here are the demystified basics of an option to ask about, so that you can be active in the conversation.
Discretionary Shares 101:
If you own your own company, or if you’re willing to set one up (it pays for itself quickly), than you can take advantage of Alberta legislation on discretionary shares.
Here’s how it works. You’re the business owner, and probably hold most of the common, voting shares. If your spouse owns some, too, then when you declare dividends you need to assign to them to the ratio of the Partners’ shares (ex. $60,000/$40,000 for a 60%/40% split).
This isn’t overly helpful if you want to declare dividends in order to income split your profits to your partner. If your lawyer set up your business without a discussion of discretionary shares, then it’s almost certainly structured on common shares and will need to adjust.
Discretionary shares allow you to split dividends at your “discretion.” Each shareholder gets a different class of share (A, B, C, etc), so you can give $0 to A, $80,000 to B, and $20,000 to C. Why? To keep your race car in the middle of the road.
Adult family members can buy discretionary shares at the outset for a buck each. As their incomes change, the amount you issue as dividends changes to level out the tax brackets.
The kids can be involved too… sort of. You can’t make your toddler Vice President and pay her a hundred grand a year. CRA has a “kiddie tax” for those cases, and it’s at the highest possible marginal tax rate (48% in Alberta).
However, you can set your kids up with discretionary shares, and simply wait to give them dividends until the year they turn 18. Issue them in-trust shares with an eye to them benefitting from income splitting later.
If you’re hitting your money-making stride and the kids are going to post-secondary, “dividend sprinkling” some profits to them will put low-tax money in their pocket for textbooks, tuition, etc, while it lowers your family’s overall tax burden.
Bottom line for all this is to talk to your accountant. We’ve given you the basics, but a professional needs to set it up.