Income splitting is a legitimate and often effective strategy Canadian couples use to reduce their overall tax burden. It involves shifting income from a higher-income spouse or common-law partner to the lower-income partner, thereby taking advantage of the progressive tax system. While not all forms of income splitting are permitted, several legal strategies are available for taxpayers looking to minimize taxes in accordance with Canada Revenue Agency (CRA) rules.
What Is Income Splitting?
Income splitting refers to the practice of allocating income between spouses or common-law partners so that more of the household income is taxed at lower marginal rates. Because Canada has a graduated tax system, higher income earners pay a significantly higher rate of tax than those earning less. By shifting income to a lower-earning spouse, the couple may pay less tax overall.
It’s important to note that the CRA has attribution rules that can apply when assets or income are transferred between spouses. However, there are several legal methods to achieve income splitting that comply with current tax laws.
Why Income Splitting Matters
Income splitting can:
- Reduce the total tax paid by a household
- Increase eligibility for income-tested benefits and tax credits
- Improve retirement income planning
- Boost refunds or reduce balances owing at tax time
Legal Income Splitting Strategies in Canada
1. Pension Income Splitting
One of the most straightforward and widely used forms of income splitting is pension income splitting. If you are receiving eligible pension income, you can allocate up to 50% of that income to your spouse or common-law partner on your tax return.
Eligible pension income includes:
- Registered pension plan (RPP) income
- Registered Retirement Income Fund (RRIF) withdrawals (age 65 and over)
- Annuity payments from a registered plan
This strategy can lead to substantial tax savings, especially when one partner is in a lower tax bracket. The couple completes Form T1032 to elect this split.
2. Spousal RRSP Contributions
A higher-earning spouse can contribute to a spousal Registered Retirement Savings Plan (RRSP), allowing the lower-income partner to withdraw the funds in retirement at a lower tax rate.
The contributing spouse gets the immediate tax deduction, but the withdrawals in retirement are taxed in the hands of the receiving spouse, provided that the funds are not withdrawn within three years of the last contribution.
This strategy is particularly useful for couples expecting a significant difference in income levels during retirement.
3. Lending Money to a Spouse at Prescribed Rates
The CRA permits income splitting through a prescribed rate loan. The higher-income spouse can lend money to their partner at the CRA’s prescribed interest rate (currently very low). The lower-income partner then invests the money and reports the investment income on their tax return.
To comply legally, the receiving spouse must:
- Pay interest annually by January 30 of the following year
- Report investment income on their tax return
- Ensure the loan is documented with a written agreement
This strategy works well for families with investment assets and a significant income discrepancy.
4. Contributing to a Spousal TFSA
Though direct contributions to a spouse’s TFSA are not allowed, a spouse can gift money to the other to contribute to their TFSA without triggering attribution rules. TFSA contributions and withdrawals are tax-free, and any investment growth is also tax-free.
This makes it an effective long-term income splitting tool with no immediate tax benefit but great cumulative impact over time.
5. Sharing Canada Pension Plan (CPP) Benefits
Couples can apply to share their CPP benefits. This doesn’t reduce the overall benefit amount but allocates portions to each spouse based on how long they lived together during their contributory periods.
CPP sharing is particularly useful when one partner is in a higher tax bracket, and it helps to balance taxable income in retirement.
6. Transferring Tax Credits Between Spouses
While not income splitting in the traditional sense, many non-refundable tax credits can be transferred from one spouse to another, including:
- Age amount
- Pension income amount
- Disability amount
- Tuition and education credits
These transfers help optimize tax liability across both partners and can reduce the total tax owed.
7. Employing a Spouse in a Family Business
If one spouse owns a business, hiring the other spouse to work in the business can be a valid income splitting method—provided the compensation is reasonable and reflects actual work done. The CRA scrutinizes these arrangements to ensure they’re legitimate.
Keep clear payroll records, issue T4 slips, and ensure CRA remittances are made to support this strategy. Unreasonable salaries or fictitious work may trigger reassessment or penalties.
8. Splitting Investment Income Using Attribution-Exempt Gifts to Minor Children
Although attribution rules usually apply to gifts made to a spouse, certain gifts to adult children or minors through trusts (like RESPs or family trusts) may be structured to avoid attribution and allow tax savings within the family.
Consult with a tax specialist or estate planner to navigate these complex strategies.
Income Splitting Strategies to Avoid
Income splitting is only effective if it complies with CRA rules. Attempting the following may lead to audits, penalties, or reassessments:
- Gifting capital or income-producing assets to a spouse without using prescribed rate loans
- Claiming tax deductions for income transferred informally between spouses
- Backdating loans or contribution dates to take advantage of lower prescribed rates
- Falsifying employment or business income to divert income to a spouse
Understanding Attribution Rules
Attribution rules are in place to prevent high-income earners from simply shifting income to lower-income spouses. These rules attribute investment income or capital gains back to the original transferor if assets are gifted improperly.
However, the attribution rules do not apply to:
- Gifts to a spouse used to contribute to a TFSA
- Income earned through prescribed rate loans when interest is paid annually
- Gifts to adult children or third-party trusts with proper structuring
How to Plan Income Splitting Effectively
Tax planning is highly personalized. To implement income splitting properly:
- Review both partners’ current and projected income levels
- Consider each spouse’s age, retirement timeline, and benefit eligibility
- Use registered plans and government sharing programs where possible
- Document all transactions and maintain clear records
Consulting a tax professional can help you structure income splitting strategies correctly while minimizing your audit risk.
Final Thoughts
Income splitting is a powerful and legal way to optimize tax outcomes for Canadian couples. Whether you’re still working, in retirement, or own a business, there are several CRA-approved methods to share income and reduce overall taxes. The key is to understand the legal boundaries, use formal structures like spousal RRSPs or pension income splitting, and keep meticulous records. With careful planning, income splitting can enhance household tax efficiency and boost your financial well-being.
Disclaimer: This blog is for informational purposes only and should not be considered financial or tax advice. Please consult a tax professional before implementing any income splitting strategy.
