Updated on 31 July 2024

In this article, we will explore the benefits and methods of using Canadian income splitting. No one likes to pay extra taxes when they reach a higher tax bracket. The Government of Canada outlines specific rules to clarify how much tax individuals pay on specific income amounts.

Thankfully, the Canada Revenue Agency (CRA) offers some relief strategies to eligible households. One of these methods is Canadian income splitting. If a higher-earning spouse can share their income with a lower-earning one, their tax bill could be less. This income distribution isn’t a one-size-fits-all strategy, though.

Their preset guidelines outline transferring income to a lower-earning spouse for tax benefits. Not everyone will qualify for income splitting; and sometimes, this strategy won’t provide a tax break.

Understanding the regulations can be overwhelming. That’s when a professional tax consultant can help you recognize when splitting an income is beneficial. Each situation requires specific forms taxpayers must complete for eligibility. Your expert accountant can help you with CRA forms like the T1032, Joint Election to Split Pension Income or the T1206, Tax on Split Income.

The Split Income Meaning Explained in Detail From the CRA

Splitting an income can be an excellent way for some couples to save on the amount of tax they owe. The CRA outlines clear rules for this tax-saving strategy and who may be eligible to use it.

This strategy is not a one-time process either. You must complete the necessary forms each year you want to divert income to a spouse or partner. This tax-saving benefit doesn’t carry over to the following taxation year, even if you qualified the year before.

Typically, for eligibility, couples must meet all these requirements:

• Both individuals must reside in Canada during the taxation year unless due to medical reasons, schooling or business activities.
• They must be married or be in a common-law partnership and not be apart for 90 days or more due to a relationship breakdown.
• The higher-earning individual must be at least 65 to qualify, but the receiving spouse doesn’t have to be 65 to benefit from this method.

According to the CRA, shifting income between spouses or family members can be through two different ways. Eligible families can allocate up to 50% of their income to help offset the taxes they owe. The household members must meet all the preset conditions in each situation.

This table outlines the sources of acceptable income:

Income/Revenue	Source
Private retirement pension plans	A company where an individual receives a salary and pension benefits until retirement age
Life annuity	Life insurance products that pay out a portion while the insurer is still alive
RRSPs (Registered Retirement Savings Plan)	Both spouses can deposit and withdraw from RRSPs, but higher-earning individuals can also contribute to a spousal RRSP before retirement
RRIFs (Registered Retirement Income Fund)	An investment company, bank, or trust that handles the distribution of your RRSP income
TFSAs (Tax-Free Savings Account)	Funds individuals deposit between the ages of 18 and 65
CPP (Canada Pension Plan)	Canadian Government pension plan based on contributed earnings between ages 18 and 65
OAS (Old Age Security)	Universal Canadian income supplement for seniors 65 years and older

Income Splitting Rules for Individuals Over 18 but Under 65 Years Old

If one adult earns significantly less and is between 18 and 64, they may qualify for income splitting. As long as they meet the other CRA predetermined conditions, distributing income can benefit a couple.

The Canadian income-splitting rules define eligibility limits for adults under 65 years old. These guidelines are in place to eliminate tax evasion. The higher-earning individual must be 65 or over with a younger partner to use this tax-saving strategy.

Income Splitting Rules for Owners of Private Corporations

Also known as income sprinkling, the tax on split income (TOSI) rules apply to household members of a corporation with high earnings. This strategy allows individuals to divert some of their income to family members, such as children, with lower tax rates.

Typically, this situation involves a high-earning individual and a family member under the age of 18. Some adults 18 and older may still qualify if they also receive the Disability Tax Credit (DTC).

This method applies to funds from some taxable dividends, income from a trust or partnerships, or taxable capital gains. In some situations, revenue generated from specific debt obligations or profits from disposing of certain properties may also apply.

Pension Splitting Rules for Individuals Over 65 Years Old

One of the most common occurrences of income splitting happens with individuals over 65 years old. Eligible couples are limited to one application to split income per calendar year.

Seniors can often allocate private pension plan income, registered plans, and other sources to spouses. In many circumstances, the lower-earning spouse doesn’t need to be 65 to be eligible for receiving this tax benefit.

Generally, individuals in retirement reside in a lower tax bracket. This makes income splitting an excellent strategy for decreasing taxes owed.

The CRA Income Splitting Rules: Do They Apply to Your Situation?

It can be overwhelming when determining if you’re eligible to disperse income among your household. Seeking expert advice from a tax professional can make this task less stressful.

However, not everyone in the accounting industry will understand the CRA rules for income splitting. It’s vital that you have a professional with the proper training to understand the guidelines. Otherwise, you risk having errors on your tax returns, leaving you open to penalties or fines.

An industry expert, like a CPA (Chartered Professional Accountant), is your best choice when you need help. These accredited individuals assist with tax planning, auditing, financial analysis, and more. If you’re unsure how to split income on your tax return, use a CPA’s assistance.

A CPA will guide you through the options because there is more than one way to work through this tax-saving benefit. From pension incomes to RRSPs to spousal loans or TFSAs, each strategy will have separate results.

The Tax on Split Income Can Be Harmful for Some Canadian Households

Sharing income with your spouse may not always be the best choice.

One example of a negative result from Canadian income splitting happens when it changes the receiver’s tax situation.

If the receiver gets enough income to place them in a higher tax bracket, their OAS or other government pension payments decrease. Not only would this arrangement put them at risk of paying more tax, but they would also receive less income than they were previously eligible for.

Increasing the income of a lower-earning spouse may also minimize or eliminate the partner’s spousal tax credit amount.

Some accounting software programs, like TurboTax, have built-in options to explore Canadian tax splitting. However, it’s vital that couples seek the professional advice of a CPA when seeking tax-saving strategies like this.

An Income Splitting Example Can Show If This Method Is Right for You

The CRA lists several income-splitting examples on its website to help provide a clear picture for couples. However, they don’t offer an online calculator to help you determine if this strategy is the best option for you.

Many banks and investment companies do have online tools to calculate income-splitting amounts. But, the results can vary significantly, which can be confusing.

It’s best to seek the advice of a professional accountant when considering income splitting on your next tax return. These industry experts will ensure all necessary forms are complete and accurate to avoid penalties or fines.

Conclusion

One unique and highly beneficial aspect of income splitting in Canada is its impact on minimizing the OAS (Old Age Security) clawback. By strategically shifting income from a higher-earning spouse to a lower-earning spouse, couples can reduce their net income to stay below the OAS recovery threshold, thereby preserving more of their retirement benefits. This method is particularly advantageous for retirees seeking to maximize their income while minimizing tax liabilities. For detailed guidelines, visit the Government of Canada's income splitting page.

FAQ

What is income splitting in Canada?

Income splitting is a tax strategy where a higher-earning spouse transfers income to a lower-earning spouse to reduce the overall tax burden.

Who is eligible for income splitting in Canada?

Typically, married or common-law partners can split income if one spouse is at least 65 years old, and they meet other CRA criteria.

What types of income can be split?

Pensions, RRSPs, RRIFs, CPP, OAS, and some dividends can be split between spouses.

How does pension income splitting work?

Up to 50% of eligible pension income can be transferred to a lower-income spouse, potentially lowering the couple’s tax payable.

Can income splitting reduce OAS clawback?

Yes, income splitting can lower taxable income, which may help avoid or reduce the OAS clawback.

Are there any risks associated with income splitting?

Increasing the income of the lower-earning spouse might push them into a higher tax bracket or reduce their eligibility for certain credits.

What forms are required for income splitting?

The T1032 form, Joint Election to Split Pension Income, must be completed annually to elect pension income splitting.

How does income splitting affect family tax credits?

Proper income splitting can optimize the use of various family tax credits, such as the spousal amount and age amount.

Is income splitting beneficial for business owners?

Business owners can use income splitting through dividends to lower the family’s overall tax burden, but they must comply with TOSI (Tax on Split Income) rules.

Can income splitting be applied retroactively?

No, income splitting decisions must be made within the tax year, and appropriate forms must be filed with that year’s tax return.